Chapter 3 - Theory of the firm

Abstract

This chapter explores the theory of the firm, addressing the question of whether a firm should rightly address environmental, social, and governance issues. It starts with Milton Friedman’s “The social responsibility of business is to increase its profits,” which argues that the firm should maximize profits and shareholders can support whatever cause they wish. A second influential paper Jensen and Meckling “Theory of the firm: managerial behavior, agency costs and ownership structure” provides a useful explanation for many corporate activities from the “agency-principal” perspective. Hart and Zingales challenge Friedman and point out that shareholders are not one-dimensional profit seekers. Stout clarifies shareholders (limited) rights and makes the case that companies satisfice several different objectives. A discussion of shareholder rights and the problem of dual-class shares concludes the chapter.