Writing in Forbes magazine, Steve Denning discusses the origins of what he terms ‘the world’s dumbest idea’: Milton Friedman’s notion that the sole purpose of an enterprise is to make money for its shareholders.
The success of the article was not because the arguments were sound or powerful, but rather because people desperately wanted to believe. At the time, private sector firms were starting to feel the first pressures of global competition and executives were looking around for ways to increase their returns. The idea of focusing totally on making money, and forgetting about any concerns for employees, customers or society seemed like a promising avenue worth exploring, regardless of the argumentation.
In fact, the argument was so attractive that, six years later, it was dressed up in fancy mathematics to become one of the most famous and widely cited academic business articles of all time. In 1976, Finance professor Michael Jensen and Dean William Meckling of the Simon School of Business at the University of Rochester published their paper in the Journal of Financial Economics entitled “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure.”
Underneath impenetrable jargon and abstruse mathematics is the reality that whole intellectual edifice of the famous article rests on the same false assumption as Professor Friedman’s article, namely, that an organization is a legal fiction which doesn’t exist and that the organization’s money is owned by the stockholders.
Even better for executives, the article proposed that, to ensure that the firms would focus solely on making money for the shareholders, firms should turn the executives into major shareholders, by affording them generous compensation in the form of stock. In this way, the alleged tendency of executives to feather their own nests would be mobilized in the interests of the shareholders.