THE ACCURACY, MARKET ETHIC, AND INDIVIDUAL MORALITYSURROUNDING THE PROFIT MAXIMIZATION ASSUMPTION

by Emily Northrop*

Abstract

This paper hinges on the distinction between “maximizing profit” and “making profit.” It recounts

from Adam Smith the ethical basis for profit making, and observes in Augustin Cournot why the

maximization assumption was introduced. Several introductory texts are examined to observe how

profit maximization is presented. The veracity of the assumption is challenged by considering: owner/

managers who focus on utility rather than profit, corporate maximization of shareholder wealth,

corporate managers who pursue personal benefits, and evidence of “corporate social responsibility.”

Milton Friedman’s 1970 New York Times Magazine essay, “The Social Responsibility of Business

is to Increase its Profits” is used to support that the ethical justification for the market system does not

rest on maximizing profit, and that individuals often have moral latitude to pursue non-pecuniary

business goals alongside seeking profit. Teaching that all firms maximize profit poorly educates

students concerning how many firms actually behave and it reinforces a pecuniary value.

Keywords: profit maximization, introductory economics, corporate social responsibility, Adam Smith

JEL Codes: A13, A22, M14, B00, B40

I. Introduction

The undergraduate introductory economicscourse, required of all business and economicsmajors and a “general education” elective for manyother students, is for most collegians the onlyformal opportunity to learn “economics.” Hencethe economics commonly taught in this course isfoundational to the college graduates’ understand-ing of how the economy operates. Key to the theorythat is developed in the introductory texts is topresent firms as aiming to maximize their profit.This paper challenges the accuracy of this presenta-tion, and addresses the related issues of the ethicof the market system and the moral latitude avail-able to those who run businesses.

This analysis hinges on a distinction betweenthe meanings of “making profit” and “maximizingprofit,” and it will begin by contending that this

contrast is highly consequential. It will thenhighlight some concepts from Adam Smith torecount the ethical basis for profit making, and willobserve from Augustin Cournot why the maximiz-ing assumption was introduced and how it becamethe convention. Next the paper will examineseveral introductory texts to observe how theprofit motivation is presented and explained. Thenthe veracity of this assumption is challengedby exploring alternative goals for firms, namely(1) owner/managers who focus on their utilityrather than their profit, (2) corporate maximiza-tion of shareholder wealth, (3) corporate managerswho to some extent enhance their personal well-being, a possibility allowed by the separationof management from ownership, and (4) aimingto adhere to various tenets of “corporate socialresponsibility.” This fourth alternative will receivespecial attention, as it was the initial motivation

* Department of Economics and Business, Southwestern University, Georgetown, TX 78626 Email:northrop@southwestern.eduI wish to thank my business colleagues in the Department of Economics and Business at South-western University, especially Mary Grace Neville, whose insistent commitment to corporate socialresponsibility inspired this paper; and to Steven Pressman for helpful suggestions.

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for the paper. The discussion will then returnto the ethical dimension of profit maximizationincluding the argument as famously advanced byMilton Friedman in his 1970 New York TimesMagazine essay, “The Social Responsibility ofBusiness is to Increase its Profits.” The paper willconclude that the assumption that firms maximizeprofit poorly educates students concerning howmany firms actually behave and it reinforces apecuniary value.

II. “Making profit” versus

“maximizing profit”

An overlooked distinction by many academiceconomists between “profit making” and “profitmaximizing” makes for a disciplinary chasmbetween them and many of their business col-leagues. These seemingly simple semantics areloaded with meaning that is crucial to the under-standing of firm behavior, and that is also para-mount as businesspeople make both day-to-daydecisions and as they construct their firms’ over-arching strategic visions. At issue is the very pur-pose of the company. Is it seeking to be profitablealongside other goals, or is it seeking to obtainall the profit that it possibly can? Being profit-able, or “making profit,” is both an incentive anda reward for providing the good or service thata firm brings to the market, and it is essentialto the functioning of the market system. “Profitmaximization” is a much more stringent purpose.It requires that all firm behaviors be directed atmaking profit as large as possible. The implica-tions of this distinction are significant.

Consider a firm that has an unprecedented acci-dent that generates some toxic solid waste. Oneof the firm’s options is to pay a considerable sumto treat this waste in a way that is consistent withgovernment environmental regulations. A secondoption is to illegally dump the waste and pay arelatively small fine that the firm knows it will beassessed. Putting aside the potential impact on thefirm’s reputation that may or may not affect itsfinancial future, a for-profit firm may neverthelessdecide to treat the waste. Conceivably this couldbe out of a commitment to the environment, anunwillingness to impinge on people who mightlive or work in the vicinity of the dumpsite, or asimple fidelity to the law. However, a firm com-

mitted to maximizing its profit will necessarilydecide otherwise. It will carefully weigh the con-siderable cost of treating the waste against payingthe small fine. It will elect to dump the wasteand pay the fine.

This example is not a straw man. According toEPA testimony before a US Senate committee,polluters have “over and over again” paid a finerather than clean up their operations. Weyerhaeuseris an example of a firm that over a period ofseveral years opted to pay fines rather than dis-continue illegal discharges (Goodstein 2011:288).The financial sector provides additional illustra-tions. The record of fraud settlements of theSecurities and Exchange Commission reveals apattern of institutions’ repeated violations offederal securities laws. Citibank is among thosewho paid a fine, promised to not repeat an ille-gal activity, and then replicated the abuse. A USDistrict Court judge included Citibank amongthe “recidivists” who have time and again paidsizable penalties for activities that remain profit-able after the fines are discharged (Stiglitz2012:204–5).

Aside from unlawful behaviors there are manylegal actions by firms that seem best understood asa careful design to squeeze out the greatest possi-ble profit. Some of the activities of Walmartappear to fall into this category, including lockingnighttime employees into stores (Greenhouse2004:1), and purchasing from vendors who pro-duce in unsafe factories (Greenhouse 2012:1). Thefood industry is rife with legal but exceedinglyharsh efforts to boost profits, e.g., slaughterhousejobs have exaggerated injury rates due to thehigh speed imposed on the workers (Dillard2008:392–3), and the introduction of the inhumanetreatment of animals in “concentrated animal feed-ing operations.”

These examples illustrate that profit “maximiza-tion” callously goes beyond what is required ofthe less stringent goal of merely being profitable.Profit maximization requires a rational weighing ofthe costs and benefits of any potential action; if andwhen that careful calculation is put aside or placedsecond to other more basic goals, the firm is nolonger in the maximization mode. This is, ofcourse, very often the case. Basic considerationsfor employees, the environment, or the law areamong the commitments that often take prece-dence over obtaining the greatest possible profit.1

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III. Adam Smith and Augustin Cournot

With the distinction between profit seeking andprofit maximizing in mind, it is instructive torevisit the writings of Adam Smith. In the para-graph from The Wealth of Nations in which heattributed the social benefits of the market to “theinvisible hand,” he credited the individual who“intends only his own security,” “intends only hisown gain,” and who is “pursuing his own interest.”These characterizations are common to the tomeand leave no doubt that Smith viewed employersof capital to be profit seeking. He used additionallanguage that approaches profit “maximization,”but when carefully examined it falls short ofendorsing the inflexibility that maximizationrequires (1937:423). To the contrary, Smithimplicitly contrasted the socially beneficial “self-interest” of capital owners to a “mean rapacity . . .of merchants and manufacturers” who soughtmercantilist favors from government and who per-niciously gained public support for impedimentsto trade among nations (1937:460). This greedyportrayal of these agents is consistent with theno-holds-barred maximization of profit. So whileSmith had the language of “mean rapacity,” hedid not apply it to “self-interested” agents whosepursuit of profit made for a socially beneficialmarket system.

There are other indications in The Wealth ofNations that Smith did not assume “mean rapacity”to be an accurate generalization. For example,in contrast to that tenor was his vision of “com-merce [as] a bond of union and friendship”(1937:460–461). He also observed that someowners of capital are more profitable “in conse-quence of a long life of industry, frugality, andattention” (1937:113), and that higher profit goesto those engaged in “disagreeable” businesses,e.g., the innkeeper dealing with “the brutality ofevery drunkard” (1937:101). By implication, otherowners choose to sacrifice profit by being lesseconomical, by working less diligently, and byenjoying more agreeable livelihoods; all are notprofit maximizers.

More significant than these indications fromwithin The Wealth of Nations is the entirety ofSmith’s prior major work, The Theory of MoralSentiments. A fundamental connection betweenthe two works is the vision of individuals as self-serving. In The Theory of Moral Sentiments this

did not extend to selfishness. That is, althoughindividuals are self-interested, they are never-theless capable of self-restraint. The basis forself-restrained moral behavior is the ability to“sympathize,” or in modern language, “empathize”with others (Ekelund and Hebert 1990:121). Thisview of people as self-regulated moral agents isconsistent with a view of self-interested economicagents who keep a check on unbridled greed, eventhough a tempering of “mean rapacity” may welldiminish profit from the highest achievable level.

Smith’s academic position was a chair in “moralphilosophy,” and he lectured on both “moral senti-ments” and political economy, so it is certainly tobe hoped that the that first volume, which devel-oped the basis for individuals’ moral behavior,is consistent with the second, which establishedthe ethical legitimization for an economy basedon the market system.2 Nonetheless this consis-tency has been contested among scholars. “DasAdam Smith Problem” refers to the dispute datingto the nineteenth century concerning whetherthe two books are compatible, for example asdescribed above, or alternatively if the self-interested agent from The Wealth of Nations is acontradiction of the moral agent in Moral Senti-ments. In a 2003 analysis of that debate, LeonidasMontes cited a 1978 JEL review article and othercirca-1980 sources that declared the issue resolvedin favor of the two works being complementary,although not all detractors from the dominant viewconceded (78–79).

Montes advanced his own support of comple-mentarity, and his argument culminated in a per-spective that will be relevant later in this article.Namely, he described Smith’s “sympathizing” as aprocess that plays out as individuals interact, aseach person is “led to form ‘certain general rulesconcerning what is fit and proper either to be doneor to be avoided’” (Montes 2003:86; quotingSmith 1976:159). That is, “For Smith, moral judg-ment is socially embedded since moral codesemerge from social interaction” (Montes 2003:84).So an individual’s sense of morality evolves; and ass/he engages with others, presumably their sense ofmorality can be affected; and in this way, society’ssense of morality evolves.

The essential point to be drawn from thisconsideration of Adam Smith is based on the dom-inant view that his two books are consistent.Accordingly, the moral agent of Moral Sentiments

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is not a contradiction of The Wealth of Nation’sself-interested profit seeker, but is at odds with thegreedy “mean rapacity” akin to profit maximizing.That is, based on his astute observations of marketbehaviors, it was self-interested profit seeking thatSmith advanced as a socially beneficial behavior.

The depiction of firms as “maximizing” profitentered economics sixty-two years after TheWealth of Nations with Augustin Cournot’sResearches into the Mathematical Principles ofthe Theory of Wealth (1971). In contrast to Smith’sapproach, Cournot’s representation was not theconsequence of observing firms’ activities, andthe book contained no accounts of greedy or ruth-less behaviors. Rather, representing firms as profitmaximizers became necessary by the employmentof a new methodology. According to Irving Fisher,Augustin Cournot was the “principle founder” ofthe mathematical school of economics as he wasthe first “writer . . . to apply mathematical pro-cesses to political economy . . . [and] win substan-tial results” (1898:120 and 135). More specificallyCournot was the first to employ differentialcalculus to model economic behavior; and in thatcontext and to suit that purpose he introduced thestringent maximizing assumption.

Cournot wrote, “We shall invoke but a singleaxiom, or, if you prefer make but a single hypothe-sis, i.e., that each one seeks to derive the greatestpossible value from his goods or his labour”(1971:44). While this assertion is remarkablysimilar to a statement from The Wealth of Nations(Smith 1937:423), neither version necessitatesprofit maximization. That is, “deriving the greatestpossible value from his goods,” is arguably to sellone’s output for as much as possible. This is notthe same as using callous or inhumane methodsin order to produce the goods at the lowest achiev-able cost; and profit accounts for both revenuesand costs. However, Cournot took the unambigu-ous next step when he modeled the decision forchoosing the price and quantity combination thatyields the “greatest possible profit” (1971:56).

This limited need and narrow application at theintroduction of the assumption of profit maximiza-tion is significant. As calculus became the lan-guage of economic theory, the maximizingassertion was adopted; and the adoption came,seemingly unwittingly, to extend well beyond thespecific mathematical application of selecting thequantity and price. Thus, it is common today to

assume that all decisions of the firm are motivatedto garner the largest possible profit.3 Accompany-ing this extension is that profit maximization,and not just making a profit, has come to be seenas inherent to the market system, and accordinglyis considered an essential ingredient to realizingthe social benefits of a market economy. MiltonFriedman made an explicit statement of thisconflation (of maximizing profit with makingprofit) in Capitalism and Freedom when hewrote, “Few trends could so thoroughly under-mine the very foundation of our free society asthe acceptance by corporate officials . . . [to do]other than to make as much money for their stock-holders as possible” (1962:133). This focus onmaximizing profit is found across the introductoryeconomics texts.

IV. Profit maximization in “principles

of economics” texts

Profit maximization is universal to the introduc-tory texts, but there are noteworthy differencesin how it is presented. Some books announcethat firms maximize profit, while others explicitlyassume that firms maximize profit. In addition,some presentations include a rationale while othersdo not. As will be pointed out, those rationalesseldom stand up under scrutiny.

Roger Arnold is among those authors whosimply announce, without explanation or any fur-ther comment, that the “firm’s objective is tomaximize profits” (2014:498). Michael Parkinmakes the same proclamation when he writes, “Afirm’s goal is to maximize profits.” But unlikeArnold, Parkin does include a basis for profitmaximizing by reasoning that a “firm that doesnot seek to maximize profit is either eliminatedor taken over by a firm that does seek this goal”(2014:224). However this stated rationale fallsshort most obviously in that Parkin fails toindicate that he is implicitly assuming a publiclytraded corporation, a condition that is hardly uni-versal. Krugman and Wells arrive at depictingfirms as profit maximizers by a more circuitousroute, and like Arnold, they fail to explain theirassertion. They begin with the “principles of deci-sion making [weighing costs and benefits] thatlead to the best possible - often called ‘optimal’ -outcome” (2013:243–44). In considering “economic”

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outcomes, and when applying the principles tofirms, the optimal outcome is that which yields“the highest possible total profit” (3013:253). Theyalso maintain, “people should use the principlesof economic decision making to achieve the bestpossible economic outcome” (emphasis in theoriginal; 2013:243).

Rather than describing firms as seeking tomaximize profit, many texts assume that firmsmaximize profit. Greg Mankiw arrives at thisassumption by entertaining, but also trivializingalternative goals. He offers that a bakery ownermight have opened her firm to altruistically pro-vide cookies to the world or “out of love for thecookie business.” He reasons instead that it is“more likely” that her motivation was to “makemoney.” He then leaps from making profit toassuming profit maximization, asserting, “thisassumption works well in most cases” (2012:236).The book by Case, Fair, and Oster makes the sameleap. After reporting that “most firms exist to makea profit,” they move to: “The analysis of a firm’sbehavior that follows rests on the assumption thatfirms make decisions in order to maximize profits”(emphasis in the original; 2012:48). Pages laterthey add, “[a]ll firms have an incentive to maxi-mize profits” (2012:147). Perhaps so, but somefirms have additional motives that may redirectthem from profit maximization.

Compared to other texts a more thorough pre-sentation is provided by Gerald Stone who statesthat alternative assumptions “have been tested.”These include “sales maximization, ‘satisfactory’profits, and various goals for market share.” Heexplains that because the predictions based onthese assumptions are not better than those follow-ing the profit maximization assumption, econo-mists assume the profit maximizing behavior. Heconcludes, “it is the primary economic goal offirms” (Stone 2012:163). Irvin Tucker also affirmsthe “basic assumption in economics” of profitmaximization, and he too acknowledges somealternatives. Namely, “managers of firms some-times pursue other goals, such as contributing tothe United Way or building an empire for the pur-pose of ego satisfaction.” But he maintains, “theprofit maximization goal has proved to be the besttheory to explain why managers of firms choose aparticular level of output or price” (2011:182).Here Tucker has correctly noted the narrow instru-mental basis for the assumption.

This brief examination of texts illustrates thatthe goal of profit maximization is asserted in avariety of ways. However a more general aspectof the presentations is its placement in close prox-imity to solving for the firms’ preferred quantityof output. Just as Cournot needed the axiom toemploy his mathematical method, modern textsbring it to bear on the same purpose. Yet in mostcases the authors do not recognize this methodo-logical motivation for the assumption. Nor do thetexts offer the moral counterpoint as Adam Smithdid with The Theory of Moral Sentiments. In theabsence of an explicit moral context, the texts’emphasis on carefully calculated decision-makingaimed at profit maximization teaches and (therebyintentionally or not) encourages this one approachto understanding and thus participating in theworld of business.

V. Recognized alternatives

to profit maximization

The introductory version of economics that pre-sents firms as profit maximizers is at significantodds with other well-recognized models of businessmotivations. In fact the academic literatures fromeconomics, finance, and business have advanced anumber of firm motives that compete with profitmaximization. A sampling from those literatureswill demonstrate that the characterization of firmsas profit maximizers meaningfully misrepresentsthe diversity of actual firm orientations.

A first counter to the profit maximization por-trayal pertains to the operations of proprietorshipsand partnerships. In these cases there is nomarket disciplining by shareholders, and theowner/manager is at liberty to maximize his/herutility in running the business. This is reminis-cent of Smith’s description of proprietors whohave distaste for “industry” and “frugality” andwho forego higher levels of profit for more per-sonally agreeable lifestyles. In a different spirit,profit might be willingly sacrificed to providemore generous wages and benefits for employees,to allow production processes that are moreenvironmentally sustainable, or to provide mone-tary or in-kind support for community charities.From yet another angle businesses may choose toforego profit to make nepotistic hires; indeed a“family business” is in a sense nepotistic by

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definition. In the United States in 2002 approxi-mately 80 percent of all US businesses were non-corporate (US Department 2006). As of 2008there were over 21 million firms that had nopayroll, and these unincorporated self-employedindividuals comprised nearly three-quarters of allbusinesses (US Department 2012). There is noa priori basis for assuming that the owners ofall of these establishments have identical utilityfunctions that lead each of them to sacrifice allcompeting goals to the one aim of achieving thehighest possible level of profit.

Turning to the corporate structure, a verycommon critique of assuming profit maximizationis highlighted in the introductory chapter ofFundamentals of Corporate Finance, a college textby Brealey, Myers, and Marcus. They argue thatprofit maximization is an ill-defined corporateobjective due to the ambiguity concerning whichyear’s profit is to be maximized. To illustrate theypoint out that cutting current maintenance budgetscan raise current profit to the detriment of profitin later periods, and that investing more of thefirm’s funds today would reduce current profit butpotentially expand future profitability. Instead ofprofit maximization they reason that “a naturalfinancial objective on which almost all share-holders can agree [is to] maximize the currentmarket value of shareholders’ investment in thefirm,” a position which quickly morphs into theirassertion that “the natural financial objective of

the corporation is to maximize market value”(bold in the original; 2012:12–13).

The wide acceptance of this approach isasserted by Danielson, Heck, and Shaffer whostate, “Shareholder theory defines the primary dutyof a firm’s managers as the maximization of share-holder wealth . . . [This] theory enjoys widespreadsupport in the academic finance community and isa fundamental building block of corporate financetheory” (2008:62). Thus maximizing shareholderwealth is a commonly accepted alternative to profitmaximization. That said, this particular alternativeis akin to profit maximization it in two essentialregards: a pecuniary value is being maximized.In the analysis to follow, those commonalities willbe the usual focus.

There are, however, standing challenges tomaximizing the pecuniary benefits of the corporateowners, whether those benefits are considered tobe profit or shareholder wealth. A first alternative

stems from the separation between the ownershipand the control of corporations, the principal-agentproblem, which can allow management to pursueits own interest, even to the detriment of share-holders. Due to the wide recognition of this con-flict of interest for managers, “incentive pay”schemes have been implemented with the inten-tion of aligning manager interest with shareholderinterest. But as summarized by Joseph Stiglitz,systems of corporate governance continue toallow “executives to do what is in their interest -including adopting compensation systems thatenrich themselves - rather than [acting] in theinterests of . . . shareholders” (2012:111). A con-sequence is the dramatic increase in executivecompensation commonly reported as the swollenratio of CEO compensation relative to that ofworkers. Mishel and Sabadish found that whenincluding the stock options that CEOs exercised,the ratio of executive compensation to worker com-pensation rose from 20.1:1 in 1965, to a 2000 peakof 383.4:1. From there the ratio fluctuated andascended again to 231.0:1 in 2011 (2012:2).

This conflict between owners and managers hasbeen in the literature at least since 1932 whenAdolf Berle and Gardiner Means originallypublished The Modern Corporation and PrivateProperty. More recent literature described howmanagers can protect their jobs by exploitingasymmetries of information to reduce the prospectsof being taken over by rival firms. This can beachieved by extending the corporation into areasbetter suited to the manager’s particular manage-ment skills, and poorly suited to the managementabilities of rivals. Another way for managers todiscourage rivals is by undertaking investmentswith a high degree of uncertainty. This clouds thevalue of the corporation and reduces the likelihoodof a takeover (Edlin and Stiglitz 1995:1301–2).When managers engage in such activities to securetheir own jobs, the firm is not attending to a pri-mary goal of pecuniary gain for the shareholders.

VI. Corporate social responsibility

The business literature on corporate socialresponsibility (CSR) is extensive and replete withalternative approaches, priorities, and terminolo-gies. “Social issues management,” “stakeholdermanagement,” and “corporate sustainability” are

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but three of the numerous approaches that havegarnered focused academic and practitioner discus-sions. In “Corporate Social Responsibility: Mappingthe Territory,” Elisabet Garriga and Domenec Mele(2004) reviewed the CSR literature and constructedfour broad categories of CSR theories.

Their first category depicts firms using CSR asan “instrument” to achieve the overriding goal ofwealth creation. So this variety of CSR does notplace it as an alternative to pecuniary maximiza-tion, but rather subservient to that aspiration. Con-sequently this type of CSR is not a challenge to theexclusive monetary aim of corporations. However,Garriga and Mele’s remaining three CSR classifi-cations are alternatives to the sole focus on pecuni-ary gain. These are “political theories” that addressthe responsible political use of corporate power,“integrative theories” that have corporationsaddressing various social issues as the causes takeon societal prominence, and “ethical theories” thatcenter on businesses doing “the right thing toachieve a good society” (2004:63–64). The ethicaltheories are arguably the furthest removed fromthe agenda of the pecuniary maximizers.

Among the ethical theories is the “universalrights” approach illustrated by the United NationsGlobal Compact. Through this program the UNsolicits commitments from firms to observe tenprinciples concerning labor, the environment, cor-ruption, and basic human rights. As introduced bythe UN webpage, “The Global Compact asks com-panies to embrace universal principles and topartner with the United Nations. It has grownto become a critical platform for the UN to engageeffectively with enlightened global business.” The10,000 firms that have signed on include SeimensAG, PepsiCo, and Unilever, and the companiescome from 140 different nations (United Nations).

According to the CSR classification by Garrigaand Mele, firms that engage in a “universal rights”version of ethical CSR are not first and foremostseeking to maximize pecuniary gain, but ratherthey hold a conviction to support some universalprinciples. However, a persistent question remainsconcerning the firms’ ultimate motivation. Forexample, although maximizing firms’ profit is notthe UN intention in promoting the Global Compactand the UN appeal to potential signatories is notmade on that pecuniary basis, the corporate deci-sion to commit to the Compact could conceivablyresult from a financial calculation by the signa-

tories. That is, the anticipated extra cost of abidingby the principles could be outweighed by theexpected benefits of a strengthened corporate repu-tation. Any such ambiguity concerning the corporatemotivation is cause for doubt among economistswho were taught, and who have taught others, theaxiom of profit maximization. This axiom predis-poses economists to interpret all CSR measures asinstrumental, regardless of how they are framed.

Skepticism among economists concerningwhether any CSR is ultimately “ethically” moti-vated must, however, contend with the practice ofmany corporations to publicly pronounce that theyare attending to the environment, customers,employees, communities, and others with a “stake”in the firm. These are corporate proclamations thatfiduciary commitments to other stakeholders sitalongside, and not below, the commitment toshareholders (Garriga and Mele 2004:64). Such apublic announcement seemingly puts the companyat explicit odds with pecuniary-maximizing share-holders, be they current or prospective owners.That despite this disadvantage some corporationsstill make public their management orientation toserve multiple stakeholders, lends credence to theauthenticity of their claims to CSR.

A recent vintage of the stakeholder model is“conscious capitalism,” which was given a decid-edly mixed evaluation by business ethicists JamesO’Toole and David Vogel. They begin by listingthe characteristics of this model including consid-eration for the firm’s multiple stakeholders, a sig-nificant role for employees in decision making,relatively modest executive compensation, andviewing profit, not as the primary goal, but asnecessary to achieving a higher purpose. Amongthe companies they associate with conscious capi-talism are Whole Foods, Southwest Airlines, andStarbucks. While they “applaud” and “admire”what such firms have accomplished, they warnagainst the hyperbolic claims of some promotersof conscious capitalism. An example of this exag-gerated enthusiasm is evident in the subtitle ofadvocate Michael Strong’s book: Be the Solution:How Entrepreneurs and Conscious CapitalistsCan Solve All the World’s Problems (bold added;2009). At root O’Toole and Vogel are skepticalthat the stakeholder model is suitable for wideadoption by firms (2011:61).

Their skepticism is based on their sense that thefirms that are adhering to this model are typically

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selling comparatively expensive goods and ser-vices to somewhat affluent consumers. This putsthose firms in the fortunate position of beingable to afford to follow the stakeholder modelby passing along some of the costs to customers.This important assertion has empirical support.In their review of the CSR literature MarkusKitzmueller and Jay Shimshack state, “marketingsurvey, stated preference valuation studies, andrevealed behavior econometrics papers all concurthat . . . consumers appear to bear at least someof the costs of CSR” (2012:74). As O’Toole andVogel see it, most firms are not in the position topass along the CSR costs.

Their doubtful assessment is further fueled bytheir observation that “virtuous capitalism is diffi-cult to sustain.” They provide specific examplesof firms that had been heralded for their princi-pled practices and social commitment, but whichwere subsequently taken over by firms that lackedthose commitments, went bankrupt, or over timesimply failed to live up to the professed ideals.BP is an unfortunate exemplar. Based on a laud-able environmental record it received high profilepress accolades for its virtuous performance. Thencame a refinery explosion in Texas, pipeline spillsin Alaska, and the 2010 Gulf of Mexico drillingexplosion that killed eleven workers and allowedan unprecedented spill (O’Toole and Vogel2011:64–65).

For O’Toole and Vogel the “zone of oppor-tunity” for applying stakeholder capitalism islimited in practical terms to the availability ofwin-win activities, meaning that the activity isprofitable for the firm as well as promoting theother social aims. They note that Walmart hasundertaken numerous environmentally friendlychanges that have also cut its costs, but the com-pany has not proceeded to other measures thatwould not provide financial reward. However theWalmart example does no more than to illustratethat for many companies CSR is “instrumental”and aimed at profit maximization, rather than“ethical,” as promoted by conscious capitalismand other stakeholder models. The Walmart exam-ple does not contradict the stakeholder model, butmerely illustrates the instrumental model.

It is important to notice that O’Toole andVogel’s skeptical view of “ethical” CSR isthe logical outcome of their explicit convic-tions that “the interests of stakeholders can and

often do diverge,” and that “at publicly tradedcorporations . . . managers have no choice but toput the interests of shareholders first” (2011:67).But despite basing their argument on thesetwo suppositions that together virtually precludeCSR (apart from the instrumental varieties), theynevertheless do recognize that conscious capi-talism is sustainable for at least some corporations,and for others it is attainable for at least someperiod of time. That being the case, their workpositions stakeholder capitalism as a feasibleexception to the axiom of profit maximization.

Apart from market forces that might limit theability of managers to trade off shareholder inter-ests to benefit other stakeholders is the more fun-damental constraint that managers have a legalfiduciary responsibility to maximize the pecuniaryinterests of shareholders. Reinhardt, Stavins, andVietor review the competing perspectives on thelegality of CSR and find that the issue is notclearly settled. They conclude that “maybe” USfirms are prohibited from foregoing profit inorder to serve the public interest, but that inany case such a prohibition is not enforceable(2008:223). That unenforceability is supported bythe large number of firms that are openly pursuingmany of the non-instrumental versions of CSR.These corporate pronouncements have continueddespite the 2010 ruling by the Delaware SupremeCourt that stated, “Directors cannot defend abusiness strategy that openly eschews stockholderwealth maximization.” This ruling has particularsignificance due to Delaware’s prominence amongthe states for the chartering of corporations,including large corporations. Indeed more thanhalf of the Fortune 500 firms were incorporatedin Delaware (Black 2007:1).

One recent response to the legal ambiguities hasbeen the development of an alternative legal optionfor terms of incorporation known as a “benefitcorporation.” This possibility is currently availablein eleven US states and is being pursued in anadditional sixteen (B Corporation 2013). Accord-ing to their charters, benefit corporations arerequired to extend their considerations beyondtheir shareholders to include other stakeholders,society at large, and the environment. They arealso obliged to make annual public accountings oftheir social and environmental impacts (Benefit2013). Some benefit corporations have elected topursue third party certification for their firm

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through the non-profit organization, B Lab. Benand Jerry’s, Seventh Generation, and Patagoniaare included in the 715 corporations that havereceived certification. Certified corporations arein 24 nations and among the 60 industries repre-sented are manufacturing, textiles, agriculture,and a variety of services (B Corporation 2013).Clearly this third party certification effort is bothyoung and small, but it is seeking to follow thesuccess of the established movement that certifiesspecific products, e.g., Fair Trade coffees andFSC lumber (Conroy 2007). Kitzmueller andShimshack report, “more than one-third of largefirms have voluntary external certifications forsocial and environmental standards” (2012:51),reflecting that this broader system of third partyaccountability has taken root.

An essential question remains concerning thefinancial impact of CSR on the firms. That is,whether corporations frame their motives as“ethical” or as “instrumental” to increasing share-holder wealth, does CSR have a positive pecuniaryeffect? The answer from the literature that statisti-cally tests the effects of CSR on the financialperformance of firms is not conclusive. A 2009meta-analysis by Margolis, Elfenbein, and Walshindicates that CSR is correlated with a small, posi-tive, and significant improvement in firms’ finan-cial performance (23). At first blush this couldbe used as evidence that despite all the insistenceto the contrary, CSR does ultimately emerge asinstrumental, and thus is not an alternative to themaximization of pecuniary gain. However thecausative direction of the relationship has not beenestablished in either theory or by empirical analy-sis, allowing that firms who see themselves as ableto afford a higher standard of conduct, do so eventhough it reduces their monetary gain from a yethigher level (2009:29). Nor do the results indicatethat the motivation to undertake CSR was toincrease profit. Perhaps the firms were genuinelyseeking to “do the right thing,” and were neverthe-less rewarded. And as the reviewers also point out,the magnitude is small. Should a firm engagein CSR to enhance its financial bottom line, itshould not expect to be richly rewarded. Finally,as others have reasoned, since CSR is associatedwith such a small monetary reward, the evidencecould be interpreted as only weak support forthe instrumental hypothesis (Kitzmueller andShimshack 2012:71).

In sum, while firms with various levels of com-mitment to various versions of CSR all striveto make profit, there are ample theoretical andevidence-based grounds for accepting that forsome companies, not every decision is based onwhether or not profit is maximized. Thus CSR isan additional successful challenge to the axiom ofprofit maximization.

VII. The market ethic

and individual morality

The ethical dimension of this discussion returnsus to Adam Smith and Augustin Cournot. Thoughprofit maximization was not what Smith defended,he did justify profit seeking. Having explained thatindividuals’ “moral sentiments” temper their self-interested behaviors, he went on to expound onhow the opportunity to obtain profit served tomotivate owners of capital to contribute to society.On these grounds he advanced the market systemas an ethical system, meaning that it worked toserve the common good.

However Smith’s observation of socially bene-ficial profit making was subsequently altered,initially by Cournot, to an assumption of profitmaximization in order to accommodate the applica-tion of differential calculus to predicting the firm’sproduction level. As this mathematical approachand its requisite assumption were adopted, theview that firms maximize profit became the con-ceptualization of all firm behaviors, and not justthe output decision. As the motive of profit maxi-mization became conflated with profit making,advocates of the market system became advocatesof profit maximization.

It is in this vein that Milton Friedman famouslypromoted profit maximization in his 1970 NewYork Times Magazine essay, “The Social Respon-sibility of Business is to Increase its Profits.” Cor-porate social responsibility was being publiclydebated at the time and his piece argued againstcorporations seeking to advance a social agenda.For the most part Friedman made a moral argu-ment concerning how individuals ought to behavein their jobs as corporate managers. He wrote:

In a free-enterprise, private-property system,a corporate executive is an employee ofthe owners of the business. He has direct

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responsibility to his employers. That respon-sibility is to conduct the business in accor-dance with their desires, which generally willbe to make as much money as possible whileconforming to the basic rules of the society,both those embodied in law and thoseembodied in ethical custom.

Of course much of the CSR literature disagreeswith Friedman’s perspective concerning the execu-tive’s rightful responsibility, and it prescribes adifferent set of executive obligations. Hence thelongstanding moral debate.

In this excerpt Friedman supported law andethical custom as restraints on pecuniary maximi-zation when he accepted that corporations shouldoperate within those confines. What he failed torecognize is how the operation of corporations candetermine and narrow those constraints (to saynothing of whose laws and customs should be fol-lowed). Based on public proclamations it is clearthat many CSR efforts are seeking to changecustomary behaviors. For example, through theGlobal Compact the UN is “seeking to embedmarkets and societies with universal principlesand values,” i.e., it is attempting to transform con-ventional behaviors. To the extent that corpora-tions sign on and maintain their commitment,customary behaviors will evolve and the standardsfacing the remaining corporations will be raised.Adam Smith supported this perspective. As LeonidasMontes emphasized (above), Smith viewed indi-viduals to be forming their moral standards asthey interact in society (2003:82–86).

Socially responsible corporations can also helpadvance the legislative process to make the legalconstraints on firms more stringent. AudenSchendler, a corporate sustainability officer andauthor of Getting Green Done, prods firms toaggressively reduce their own carbon footprintsand then to “force the leaders to lead.” Headmonishes firms to “use their own businessas a club to batter legislators with advocacy”(2009:97). Firms also can play a role in the regu-latory sphere. Schendler’s own employer, AspenSkiing Company, filed an amicus brief to supportcarbon dioxide regulation in the Massachusettsv. EPA case that went before the US SupremeCourt. In this way the company contributed to thelegal process that ended with an expansion of EPAregulation under the Clean Air Act to include

carbon dioxide (2009:92-93). Milton Friedmanoverlooked that CSR companies have specialmoral authority to exert in changing society’s legalstandards for business operations.

In his essay Friedman also moved beyond pro-moting individual behaviors when he made anethical defense of the market system. He asserted:

The political principle that underlies themarket mechanism is unanimity. In an idealfree market resting on private property, noindividual can coerce any other, all coopera-tion is voluntary, all parties to such coopera-tion benefit or they need not participate.There are no values, no “social” respon-sibilities in any sense other than the sharedvalues and responsibilities of individuals.Society is a collection of individuals and ofthe various groups they voluntarily form.

While Friedman was explicitly arguing againstcorporations taking on social responsibilities, whathe overlooked here is that CSR is completely con-sistent with the ethical framework of the “idealfree market” that he espoused. CSR is not an abro-gation of private property, it is not coercive(certainly as viewed by economists), and since itis voluntary it can be presumed to be mutuallybeneficial. Today (even if possibly less so in 1970when Friedman published his essay) corporateowners are among the voluntary participants. Asnoted by Kitzmueller and Shimshack, the adop-tion of corporate social responsibility is currentlycommon, with over half the Fortune Global250 firms and 10 percent of the S&P 100 pro-viding regular public CSR reports. They notedthat The Economist is among those who nowview CSR as mainstream (2012:51). Shareholderswho are displeased with a firm’s CSR initiativesneed not become or remain owners.4 It is alsonoteworthy that in this excerpt in which Friedmanwas defending the ethics of the market system(and not providing moral instruction to execu-tives), his justification did not hinge on profitmaximization, but rather on voluntary behaviors.That is, there is nothing in his statement of theideal free market ethic that either presupposesor requires making as much money as possible.So in this instance of promoting the market systemFriedman did not conflate making profit withmaximizing profit.

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The ethical defense of the market systemrequires the profit motive and that behaviors arevoluntary. Neither of these is challenged byCSR. When firms engage in CSR the financialincentive and reward of profit making does notgo away; these firms still seek profit, but that goalis (in non-instrumental cases) placed alongsideother motivations. And CSR measures are volun-tary. What the mainstreaming of CSR has doneis to expand the creative thinking around and thelegitimacy of corporate managers serving othervalues in addition to making profit. In essence,the expanded adoption of CSR has expanded thescope for individual moral agency within theethical system provided by the market.

VIII. Teaching only profit maximization

miseducates students

To represent companies as profit maximizersis to overgeneralize and to misrepresent firms.Proprietorships, partnerships, and non-publiclytraded corporations do not face the takeover threatthat is posited to enforce profit maximization andthese firms are free to pursue additional goals ofsignificance to the owners. Even corporations thatdo have shareholder pecuniary gain as their onlygoal may well sacrifice profit in order to maxi-mize long-term shareholder value. In addition,advantaged by asymmetries of information, corpo-rate management may to some extent prioritizetheir personal aspirations for high compensationand job security and thereby reduce the corporateprofit. Finally, consistent with various of the CSRmodels, corporations may orient their effortstoward multiple ambitions and not have a solitarygoal of profit maximization. This range of alter-natives demonstrates that economists err whenthey teach only that firms maximize profit.

Economists further err when they rest the bene-fits of voluntary exchange on the motive to maxi-mize profit. The ethical foundation of the marketsystem rests on non-coercion, but not on profitmaximization. Within that ethical system there isoften latitude for alternative firm motivations andindividual moral agency. To the extent that econo-mists teach that firms must maximize profit inorder to avoid various unattractive market disci-plines (e.g., being taken over or going out of busi-ness), economists are fostering an exclusive

business focus on profit. To the extent that studentsare learning what they are being taught, they arepredisposed in any future roles in a for-profit busi-ness to focus on the financial bottom line. Theywill also be predisposed in their consumer role tobe dubious of corporate CSR claims and will per-haps discount opportunities to support businessesthat have values that align with their own. Thus theprofit maximization presentation limits the moralimagination of students and discourages them frombringing their own diverse moral priorities to theirmarket exchanges.

To the degree that the introductory economicstexts support the market system, they are advancingthat ethical system. This is often done with anapproving reference to the working of Adam Smith’s“invisible hand.” To the degree that the texts ratio-nalize and normalize profit maximization, they arerationalizing and normalizing one particular moralchoice. But rather than explicitly advancing thismoral position, the promotion is unwittingly implicitwhen alternatives to an exclusive pecuniary goalare assumed away or are not seriously entertained.

As educators, economics text writers and instruc-tors should enlighten their students about the varietyof business alternatives to maximizing the firm’specuniary gain. While profit making is essential,profit maximizing is one viable purpose amongmany. As societies struggle to meet some recurrentproblems (e.g., global poverty) and some unprece-dented challenges (e.g., climate change), teachersof economics should acknowledge that some firmsare elevating social and environmental objectivesto a position alongside their profit objective.

Notes

1. At first blush it appears this decision calculuscould be accommodated by the conventionalmodel of maximizing profit subject to con-straints, with the simple inclusion of oneor more additional social or environmentalconstraints. However as will be illustratedbelow, the introductory texts do not explic-itly present the firms’ motive as maximizingprofit subject to a constraint, and this paperconcerns the introductory texts. In addition, inthe usual model the constraints are exogenousto the firm, e.g., the market price of inputs,while in the current discussion some firms

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may opt for additional self-imposed con-straints, e.g., “reducing CO2 emissions 25 per-cent by 2015.” Since any such added objectiveis optional, modeling it as a “constraint” ismisleading in that the limitation could be setaside simply should the firm opt to do so.Finally, when voluntary goals are not rigidlydefined, e.g., “reducing CO2 emissions,” theyare better conceptualized as a goal that couldbe more or less aggressively pursued in lightof the amount of profit sacrificed, rather thanas a fixed constraint on profit maximizing.

2. Throughout this paper I will use “moral” inreference to individual behaviors, and “ethi-cal” when referring to the market system.This word usage is at variance with commonparlance that conflates “morals” and “ethics”;neither does it conform to a more nuanceddistinction made by many philosophers. How-ever, this simple distinction is useful in clari-fying my argument.

3. It is noteworthy that the assumption of profitmaximization is common to mainstream eco-nomics and Marxian economics, and that theassumption was instrumental to the deductivelogic of the models adopted in these separatetraditions. However, while Cournot came tothe assumption without reference to observa-tions of actual business enterprises, Marx scru-tinized the activities within the burgeoningindustrial sector. What Marx saw is consistentwith “meanly rapacious” profit-maximization.

4. It is arguable that opting to not purchaseshares in a CSR firm is altogether differentfrom having to contend with a decision toadopt CSR by a firm in which a shareholderalready holds stock. On the other hand, atthis point CSR is mainstream, so shareholdersshould be aware that it is a part of the cor-porate landscape. And as reported above,CSR is correlated with a small increase instock values, making it unclear that share-holders are harmed.

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