Managers and Market Capitalism

by Rebecca Henderson & Karthik Ramanna

Overview — In whose interests should managers act, particularly when structuring market regulations in highly technical or specialized matters that are largely outside public purview? This paper raises questions about the role of managers in sustaining the conditions for market capitalism to achieve its normative objectives. Rebecca Henderson and Karthik Ramanna begin with a discussion of the normative arguments for fully competitive markets as a resource allocation mechanism in complex societies. They suggest that Milton Friedman's assertion that the business of business is to increase its profits was in fact a moral assertion rooted in this normative framework. Next, they discuss the conditions for the existence of competitive markets and offer a brief overview of the institutions that provide them, noting that a combination of for-profit, pure public, and public-private institutions are needed to sustain capitalism. This perspective has two implications for managers. First, in many cases the opportunity to provide market completing institutions is a significant profit opportunity. Second, in those cases in which the provision of an institution is a scarcely attended political process or a public good that cannot be easily realized by managers, managers may have a duty to mitigate this market incompleteness even if it is not immediately profit maximizing to do so. Ultimately, managers' actions are likely to shape the moral and political legitimacy of market capitalism. Key concepts include:

Managers may have a responsibility to structure market institutions so as to preserve the legitimacy of market capitalism, even if doing so is at the expense of corporate profits.
Both conceptually and empirically, it is difficult to specify where legal self-serving lobbying ends and overt corruption of regulation begins. Even in those cases in which self-interested lobbying is clearly legal, it may not be consistent with the ethical objectives of capitalism.
Distorting market rules, whether through legal lobbying or through overt corruption, distorts market outcomes and erodes political and social support for market capitalism.
Finding a way to reconcile economic models of the role of the corporation and of business activity with the reality of events such as the financial crisis and the prevalence of "crony capitalism" and corporate corruption is one of the most important challenges of our time.

Author Abstract

In a capitalist system based on free markets, do managers have responsibilities to the system itself, and, in particular, should these responsibilities shape their behavior when they are attempting to structure those institutions of capitalism that are determined through a political process? A prevailing view-perhaps most eloquently argued by Milton Friedman-is that managers should act to maximize shareholder value, and thus that they should take every opportunity (within the bounds of the law) to structure market institutions so as to increase profitability. We maintain here that if the political process is sufficiently "thick," in that diverse views are well represented, and if politicians and regulators cannot be easily captured, then this shareholder-return view of political engagement is unlikely to reduce social welfare in the aggregate and thus damage the legitimacy of market capitalism. However, we contend that sometimes the political process of determining institutions of capitalism is "thin," in that managers find themselves with specialized technical knowledge unavailable to outsiders and with little political opposition-such as in the case of determining certain corporate accounting standards that define corporate profitability. In these circumstances, we argue that managers have a responsibility to structure market institutions so as to preserve the legitimacy of market capitalism, even if doing so is at the expense of corporate profits. We make this argument on grounds that it is both in managers' self-interest and, expanding on Friedman, managers' ethical duty. We provide a framework for future research to explore and develop these arguments.