Saturday, August 10, 2019

Company Town

Milton Friedman, shareholder primacy’s true north, wrote:

In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to their basic rules of the society, both those embodied in law and those embodied in ethical custom.

Much judicial, political, and academic ink has been spilled over the first part of this pronouncement, but the second part has always baffled.  What ethics?  Whose ethics?  How do we identify ethical customs that are not instrumental in generating higher profits (because if they were, there would be no need for the qualification; we would simply recognize that pursuit of profits may include pursuit of community goodwill because in its absence it may be hard to sell one’s product).

The recent tragedies in El Paso and Dayton have raised these questions anew.  Cloudflare, which provides various website and internet security services, dropped 8chan (a breeding ground for violent white supremacist content and the site where the El Paso shooter posted a racist screed) as a client, thus knocking 8chan offline.  In so doing, its CEO, Matthew Prince, explained:

We continue to feel incredibly uncomfortable about playing the role of content arbiter and do not plan to exercise it often. Some have wrongly speculated this is due to some conception of the United States' First Amendment. That is incorrect. First, we are a private company and not bound by the First Amendment. Second, the vast majority of our customers, and more than 50% of our revenue, comes from outside the United States where the First Amendment and similarly libertarian freedom of speech protections do not apply. The only relevance of the First Amendment in this case and others is that it allows us to choose who we do and do not do business with; it does not obligate us to do business with everyone.

Instead our concern has centered around another much more universal idea: the Rule of Law. The Rule of Law requires policies be transparent and consistent. While it has been articulated as a framework for how governments ensure their legitimacy, we have used it as a touchstone when we think about our own policies….

Cloudflare is not a government. While we've been successful as a company, that does not give us the political legitimacy to make determinations on what content is good and bad.

Two years ago, Cloudflare discontinued service to the Nazi site Daily Stormer.  At that time, Prince said:

Now, having made that decision, let me explain why it's so dangerous….  Without a clear framework as a guide for content regulation, a small number of companies will largely determine what can and cannot be online. … Law enforcement, legislators, and courts have the political legitimacy and predictability to make decisions on what content should be restricted. Companies should not…

In an internal email to Cloudflare employees at that time, he was more blunt:

[T]his was an arbitrary decision. It was different than what I’d talked talked with our senior team about yesterday. I woke up this morning in a bad mood and decided to kick them off the Internet. … It was a decision I could make because I’m the CEO of a major Internet infrastructure company….  Literally, I woke up in a bad mood and decided someone shouldn’t be allowed on the Internet. No one should have that power.

Prince depicts himself as a man caught between conflicting ethical principles.  Which apply? 

After El Paso and Dayton, Andrew Ross Sorkin penned an open letter to Walmart’s CEO, the country’s largest seller of guns:

It is clear that this country is suffering from an epidemic that law enforcement and politicians are unable or unwilling to manage.

In the depths of this crisis lies an opportunity: for you to help end this violence….

You could threaten gun makers that you will stop selling any of their weapons unless they begin incorporating fingerprint technology to unlock guns, for example. You could develop enhanced background checks and sales processes and pressure gun makers to sell only to retailers that follow those measures.

You have leverage over the financial institutions that offer banking and financing services to gun makers and gun retailers as well as those that lend money to gun buyers….

It would be easy for you, and other chief executives, to argue that controlling the gun violence epidemic is Washington’s responsibility, not yours. But in an era of epic political dysfunction, corporate executives have a chance to fill that leadership vacuum.

All of this just begs the question of how much we should expect public-style regulation from the private companies that dominate our lives.  Here’s Kara Swisher on Cloudflare’s decision:

It’s long past time for the digital giants to build safety into the DNA of products from their conception. The next crop of tech companies should think about safety from the get-go….

[W]hat we have today, as I have written before, are giant digital cities that were built without adequate police, fire, medical or safety personnel, decent street signs or any kind of rules that would make them work smoothly.

Amazon’s dominant position in commerce had led it to create its own private court system for adjudicating disputes, which has given rise to an industry of Amazon-court “lawyers” to help merchants navigate it.  Facebook, as well, has proposed creating something like an internal court system for handling content disputes.

All of these examples strike me as peak “publicness,” in Hillary Sale’s terminology.  When companies take on public responsibilities, the public demands that they act with the transparency and concern for public values that we ordinarily expect of governments.  Or, to put it another way, Matthew Prince is right: His company does not have legitimacy to make these decisions, but made they must be - which is why greater public demands will be placed on Cloudflare to anticipate them, prepare for them, and avert the next El Paso rather than simply react to it.  (Check out Matt Levine’s description of the terms of Facebook’s privacy settlement.)

How successful is that effort likely to be?  Well, with both apologies and nods to Friedman, if corporations are like governments, an appeal to ethics alone isn’t going to cut it.  As FDR reportedly once told a group of labor activists, “I agree with you; I want to do it; now, make me do it.”  In the context of government, that means constituent anger and threatened disruption; companies may not be so different.  So the real question is whether public outrage can become sufficiently expensive to force change.  And that has yet to be seen.

Ann Lipton | Permalink


I suspect what Friedman was talking about with respect to "ethics" is the customary fairness in ordinary business transactions that contract and commercial law expects of merchants. These are not "law" in the formal sense but contract law takes them into account in deciding business disputes.
On the other issue, it seems to me a problem to encourage big companies to use their power to coerce suppliers and customers into falling into line with their political views. Would we be comfortable if Hobby Lobby or Chick-fil-A started pressuring suppliers to stop providing abortion coverage to workers?

Posted by: Stan Fardle | Aug 10, 2019 10:50:36 AM

I'm not sure Friedman can so easily be cabined - I'm sure we can imagine "customary" ethical constraints in dealing with employees, unions - and from there the field is open. Beyond that, I agree - when I teach my students about Ford and his high wages, I also tell them about his other idiosyncrasies. Is this who we want dictating public policy? OTOH, what happens when no one else steps into the void?

Posted by: Ann Lipton | Aug 10, 2019 10:56:57 AM

This is a powerful post, Ann. I appreciate you sharing these ideas and perspectives.

I find the issues you write about here quite difficult, especially in the realm where private economic actors essentially substitute for government. The disagreement about what "ethics" is (and who its beneficiaries therefore are) is critically important. With a fractured field of decision-makers governing social and ethical conscience (i.e., where government is not the sole or commanding governance voice), there is no clear message or enforcement path. I have to do a lot more thinking about this. Thanks for encouraging that.

Posted by: joanheminway | Aug 11, 2019 9:04:40 AM

So glad you liked the post, Joan! I too find these to be very difficult issues - I am constantly going back and forth on how I feel about them.

Posted by: Ann Lipton | Aug 11, 2019 9:11:06 AM

I want to comment on Walmart and then Milton Friedman's famous pronouncement.

In regard to Sorkin's Walmart letter, I really don't get it. Walmart has been incredibly responsive to the tragedies caused by guns over the last five years. They do not sell assault weapons or handguns. It is my understanding they only sell rifles and shotguns. I believe the shooter in El Paso was using an assault rifle and the shooter in Dayton was using an assault pistol that had been purchased online and then had modified at a local arms dealer. For better or worse we have the Second Amendment and Walmart seems to be staying within the spirit of a relatively narrow interpretation. Unfortunately, the focus on Walmart by Sorkin, Warren, Sanders and A.O.C. will probably create the impression among the general public that Walmart sells assault weapons and was somehow directly linked to the recent shootings. Moreover, from a corporate governance perspective, Walmart is controlled by the heirs of Sam Walton and therefore are immune to shareholder activism. Therefore, the focus on Walmart seems to me pretty misguided, harmful to the reputation of Walmart, and will probably not accomplish anything.

In regard to Friedman's statement, I like to think of it in the context of agency costs. Here what I wrote in my recent article, Enhancing the Value of Shareholder Voting Recommendations (forthcoming, Tennessee Law Review),, in the context of board voting recommendations:

"Second, there is also the issue of agency costs (“the economic losses resulting from managers’ natural incentive to advance their personal interests even when those interests conflict with the goal of maximizing their firm’s value” ). As explained by Professor Paul Rose:

Under a classic theory of the firm, agency costs in the corporate context increase as ownership is separated from control. As the manager’s ownership of shares in the firm decreases as a percentage of the total, the manager will bear a diminishing fraction of the costs of any nonpecuniary benefits he takes out in maximizing his own utility. To prevent the manager from maximizing his utility at the expense of the shareholders, shareholders will seek to constrain the manager’s behavior by aligning the manager’s interests with the shareholders’ interests.

These classical agency costs would also create bias and reduce the precision of board voting recommendations.

But this does not mean that the board of directors and its executive management are simply unconstrained actors generating agency costs at will. They are constrained by the law and their ethics. They are human beings after all, fearful of violating criminal law and potentially facing imprisonment or financial penalties, breaching their fiduciary duties of care and loyalty and thereby potentially facing financial liability, damaging their reputations, and violating their own ethical norms. According to Milton Friedman:

In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.

Such legal and ethical rules, which are allowed to change over time, create boundaries that discourage the board of directors and executive management from entering into unacceptably harmful corporate decisions. For example, selling assault weapons.

Posted by: Bernard S. Sharfman | Aug 12, 2019 6:59:21 AM

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