In the roughly five decades following the publication of Milton Friedman’s iconic advocacy of profitability as the single normative goal of managers of public companies, innumerable articles and editorials have been written criticizing Friedman’s thesis. Even President Joe Biden publicly rejected the argument that a corporation’s primary responsibility is to its shareholders.

The primary criticism of Friedman’s position is that a sole focus on profitability ignores the social responsibility that businesses have to other constituents (besides shareholders) including consumers, employers, suppliers of inputs, the broader communities where companies do business and, for many, the environment. Today, this critique is associated with environmental, social and governance (ESG) initiatives, which prioritize broader social goals even if they harm the financial interests of shareholders.

And of course, this is no longer simply an academic debate. Governments around the world, including in Canada, have sought to circumscribe the authority of corporate executives and board members and impose broad ESG reporting obligations and other ESG-related mandates on companies.

Many proponents of ESG argue that corporate managers face no necessary tradeoff between prioritizing ESG initiatives and acting as responsible fiduciaries for shareholders—that companies can do well for their shareholders by doing good for other stakeholders, since socially responsible businesses will enjoy higher risk-adjusted profits than their less socially responsible counterparts. But in fact, there’s no consistent relationship between the ESG rankings assigned to companies and those companies’ stock market performance.

Still, some ESG proponents acknowledge that while prioritizing ESG initiatives may harm the financial interests of shareholders, the benefits to society (environmental improvements, greater equality in the distribution of income and wealth, enhanced community amenities, etc.) exceed the harm to shareholders. They further argue that an increasing number of shareholders will accept lower financial returns in exchange for companies increasing their ESG-related commitments, as evidenced by the growth of ESG-themed mutual funds and related investment vehicles.

But again, in reality, the growth of ESG-themed investing is not a dispositive argument for ESG. Indeed, a case can be made that shareholders and many other stakeholders will all be worse off if corporate executives and board members adopt the ESG model. As noted in a new analysis published by the Fraser Institute, as a company’s objectives become more complex and difficult to quantify, the harder it becomes for shareholders and other stakeholders to monitor corporate performance and reward (or punish) executives and board members for the organization’s performance. Even well-intentioned and conscientious executives will likely be overwhelmed by the tradeoffs associated with balancing the competing interests of different groups of stakeholders. More worryingly, ESG-style governance provides executives and board members greater scope to promote their own monetary interests at the expense of all stakeholders including shareholders.

Clearly, despite any wishful thinking on behalf of ESG proponents, there are practical limits to abandoning shareholder-focused governance. If societies want to promote broad social objectives, they should employ laws and regulations—not rely on executive fiat. Executives and board members should focus on ensuring that their organizations operate efficiently, meaning they should aim to maximize profits within the legal and regulatory framework set by democratically elected governments. When acting as corporate managers, their primary responsibility is to shareholders.