Is the purpose of business to make a profit or maximize shareholder value?Starting in the early 1980s, the “shareholder value” model of the firm transformed the way large corporations, in particular, manage themselves and compensate their executives. The idea that the sole purpose of business is to maximize shareholder value is the outgrowth of something called “agency theory.” Agency theory was thrust into the spotlight in 1976 by two business school academics, Michael Jensen and William Meckling. Finding the performance of U.S. conglomerates during the 1970s wanting, Jensen and Meckling prescribed a remedy consisting, in part, of the use of stock options to better align the interests of corporate management and shareholders. The idea was wildly influential and quickly found favor among professional money managers, the emerging private equity industry, and the burgeoning finance faculties of business schools. “Maximizing shareholder value” became a mantra for a generation of MBAs. While the maxim of optimizing shareholder value has been treated as received wisdom, it was not always so. In the early 19th century, charters typically granted the benefits of incorporation (indefinite organizational life, limited liability, and the right to issue stock) in exchange for the performance of a public duty. That is, early corporations (at least in theory) worked for the good of their shareholders and the public. The emphasis placed by agency theory upon the welfare of shareholders is a relatively recent phenomenon. In contrast, Peter Drucker asserted, “The purpose of business is to create and keep a customer.” The idea has a neatness and apparent objectivity that is appealing. It offers us the prospect of weighing our decisions using the scales of our customers’ wants, needs, and satisfaction. But, what if our customers want something that is contrary to the needs of our employees or the environment or our communities? What guidance does such a purpose really provide? Drucker was too subtle a thinker to apply a useful rule of thumb dogmatically. He also said, “If the managers of our major institutions, and especially of business, do not take responsibility for the common good, no one else can or will.” As I understand Drucker, he recognized that while having a customer defines business, the purpose of business encompasses a rather broad scope of responsibilities.
If the managers of our major institutions, and especially of business, do not take responsibility for the common good, no one else can or will.John Mackey, co-founder and co-CEO of Whole Foods Market, takes a pragmatic approach to the question. In his experience, the “passion” of the founder-entrepreneur defines the initial purpose of a business. Mackey believes that the purpose subsequently co-evolves with the needs and wants of other stakeholders, including customers, employees, and communities. I suspect Mackey would agree that profit, in and of itself, usually isn’t an objective. Rather, profit is a requirement of business. As my friend Tom McMakin once told me, “Profit means that you get to keep working.” Consequently, I reject the notion that the purpose or objective of business is to maximize profits. I believe that profit is a constraint – in order to pursue its objective, a business must generate a sufficient profit to accumulate, attract, and retain requisite investment capital. I’ve come to view business as an expanding game of plate spinning, where each plate represents an important resource: customers, investors, employees, and community members. Each such resource becomes a critical constraint at different times, so the role of management is to attempt to anticipate constraints and “juggle” resources in order for the business to survive and thrive.
I’ve come to view business as an expanding game of plate spinning, where each plate represents an important resource: customers, investors, employees, and community members.The purpose of business, in my view, is to help us live better and more meaningful lives. As to the purpose of life? I leave that for you to define.