It has been over a century since the renowned economist Milton Friedman put forward a fundamental question: What is the role of corporate social responsibility in business?
In a keynote speech at the recent CEIBS Innovation Forum Hong Kong, CEIBS Assistant Professor of Finance Shan Hongyu discussed the evolution of economic theories on ESG, and outlined current ESG research trends in measurement, matching, pricing, and impact.
"The social responsibility of business is to increase its profits."
This part-quote from Nobel Prize-winning economist Milton Friedman is routinely cited by the proponents of capitalism regarding ESG issues in business. However, frequently (and sometimes conveniently), the rest of the quote is parked to one side, along with its all-important caveats. The full quote is:
"There is one and only one social responsibility of business — to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud."
This full quote, and its bearing on economic theory, is essential in aiding our understanding of ESG issues in business. It is especially useful when trying to track how our perceptions have ebbed and flowed over the past 130 years as humanity has grappled with the challenging concept of balancing profitability with sustainability.
01
Does Milton Friedman's statement stand up today?
From the 1970s onwards, Milton Friedman's view was widely, almost universally embraced by the worldwide business community. It took the unprecedented financial crisis of 2008, where the exact same profit maximisation mentality on Wall Street wiped out $2 trillion in economic output overnight, to put a serious dent in our collective confidence regarding this approach.
So, in 2024, around 15 years after the crash, 54 years after Milton Friedman made his famously quotable statement in the New York Times, and roughly 130 years after the nascent idea of CSR came into being, does the statement still hold up to scrutiny? I believe it does, but it only holds up with the following four (often ignored) micro-foundations in place.
Horizon: The business must take the broader view of maximising value for all shareholders, not one single entity. A short-term horizon unduly focused on the immediate financial gains of a single, or select few, shareholders does not produce socially responsible outcomes.
Competitive Market: As Friedman said, a competitive market is essential to producing socially responsible outcomes in business. Companies with monopolistic control of a market routinely abuse their market position and social capital (e.g.: customers' personal data) to maximise their profits without proper consideration of ESG factors.
Institutions: Well-developed, well-functioning legal and regulatory systems are needed to protect the rights of the most vulnerable groups in society. They curtail the worst impulses of businesses and guide them towards making socially responsible decisions.
Shareholder Welfare: Maximising shareholder value is not always the same as maximising stock price. Increasingly, today's investors want to buy into something that aligns with their political, social, and environmental agenda. Therefore, improving shareholder welfare today means taking a more holistic approach, incorporating both price-dimensional and non-price-dimensional preferences.
Only when these four micro-foundations are in place can businesses satisfy both their profit incentive and their broader social responsibilities in a consistent manner.
02
The bigger picture – What do we collectively think about ESG?
Zooming out from the specifics of economic theory, the public's perception of ESG – and how businesses either champion or ignore it – has changed over time. Thanks to the latest research by Houston, Kim and Li (2024), which apply AI and machine learning to the context of corporate responsibility, we're now in a much better position to evaluate this relationship between ESG issues and public sentiment over the past 130 years.
If we connect the dots between the shared opinions of the brightest minds from 1890 to 2024, two striking trends emerge regarding Environmental (E) and Social (S) issues:
Public attention regarding E issues rises during times and among societies of relative prosperity. It also rises in times of heightened political and ideological division.
Public attention regarding S issues rises in times of economic and social instability. It also rises during periods of high volatility in real GDP growth.
Put simply, people care more about environmental issues when their financial position is secure and when the political discourse of the day is more fragmented. Public concern over social issues is often ignited when the economy is performing badly, when they are feeling the pinch or when their social structures are shifting and they feel unsure of their place in society.
In 2024, a time of increasing global inequality, greater political and ideological division, and increasing economic volatility, it is thus hardly surprising that across the world people are paying more attention to both environmental and social issues. Companies, therefore, need to consider their own ESG practices more closely than ever before, and be ready to engage more directly and transparently with their investors and end customers on the ESG issues that matter most to them.
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Looking ahead – Where do we go from here?
Though we are standing on the shoulders of 130 years of data, discussions, and reflections on ESG, the work is by no means done.
Continually improving our understanding of the role and public perception of ESG in business is invaluable for guiding companies to be more socially responsible. Accordingly, academics are advancing the frontiers of knowledge about ESG issues. The four key areas of focus for this line of academic enquiry today are:.
Measurement: How can we develop a set of consistent, objective and comparable measurements on ESG issues and approaches?
Matching: How can we better match sustainable products with sustainable customers, or sustainable lenders with sustainable creditors?
Pricing: How can we price financial instruments like green bonds, carbon pricing, and green stocks fairly, transparently, and effectively?
Impact: How can we accurately gauge the societal impact of a given ESG measure?
By exploring these areas, academics, businesses and the wider public can all play a part in improving our collective understanding of ESG issues and how best to approach them. To think like an economist in an era where corporate social responsibility is gaining in popularity and importance, the following three attitudes are necessary:
Respect facts and believe in the power of data and scientific approaches.
Address the most urgent problems with real-world implications.
Investigate deeply, but think broadly, while embracing the unknown.
This summary is based on a keynote speech entitled "130 years of Corporate Social Responsibility: What have we learned from the great minds?" by Assistant Professor of Finance Shan Hongyu at the recent CEIBS Innovation Forum Hong Kong.
Prior to joining CEIBS, Prof. Shan Hongyu was Assistant Professor of Finance at Gabelli School of Business at Fordham University. Prof. Shan received his Ph.D. in Finance from University of Florida and B.A. in Economics from University of Michigan.
Prof. Shan's research interests focus on understanding the impact of climate change and other ESG initiatives on financial markets and corporate decision making.
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