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Striking The Right Balance

Adam Smith described how an "invisible hand" guides companies to maximize profits in a way that benefits society. However, modern corporations are much larger and global, so the invisible hand may no longer reliably guide them. There is debate around whether companies should maximize shareholder profits or strike a balance with other stakeholders. Most academics argue that companies should maximize stock value within legal constraints. However, GE's CEO Jeffrey Immelt believes companies need to do more by considering their reputation with various stakeholders, which can also maximize stock value in the long run. While both Citigroup and GE aim to maximize stock prices, their CEOs take different approaches, with Citigroup focusing directly on profits and GE taking a broader view of reputation and

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134 views2 pages

Striking The Right Balance

Adam Smith described how an "invisible hand" guides companies to maximize profits in a way that benefits society. However, modern corporations are much larger and global, so the invisible hand may no longer reliably guide them. There is debate around whether companies should maximize shareholder profits or strike a balance with other stakeholders. Most academics argue that companies should maximize stock value within legal constraints. However, GE's CEO Jeffrey Immelt believes companies need to do more by considering their reputation with various stakeholders, which can also maximize stock value in the long run. While both Citigroup and GE aim to maximize stock prices, their CEOs take different approaches, with Citigroup focusing directly on profits and GE taking a broader view of reputation and

Uploaded by

Shakeel Iqbal
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Striking the Right Balance

In 1776 Adam Smith described how an “invisible hand” guides companies striving
to maximize profits so that they make decisions that also benefit society. Smith’s
insights led economists to reach two key conclusions: (1) Profit maximization is
the proper goal for a business, and (2) the free enterprise system is best for society.
However, the world has changed since 1776. Firms then were much smaller, they
operated in one country, and they were generally managed by their owners. Firms
today are much larger, operate across the globe, have thousands of employees, and
are owned by millions of investors. Therefore, the “invisible hand” may no longer
provide reliable guidance. If not, how should our giant corporations be managed,
and what should their goals be? In particular, should companies try to maximize
their owners’ interests, or should they strike a balance between profits and actions
designed specifically to benefit customers, employees, suppliers, and even society
as a whole?

Most academics today subscribe to a slightly modified version of Adam Smith’s


theory: Maximize stockholder wealth, which amounts to maximizing the value of
the stock. Stock price maximization requires firms to consider profits, but it also
requires them to think about the riskiness of those profits and whether they are paid
out as dividends or retained and reinvested in the business. Firms must develop
desirable products, produce them efficiently, and sell them at competitive prices,
all of which also benefit society. Obviously, some constraints are necessary—firms
must not be allowed to pollute the air and water excessively, engage in unfair
employment practices, or create monopolies that exploit consumers. So, the view
today is that management should try to maximize stock values, but subject to
government-imposed constraints. To paraphrase Charles Prince, chairman of
Citigroup, in an interview with Fortune: We want to grow aggressively, but
without breaking the law. Citigroup had recently been fined hundreds of millions
of dollars for breaking laws in the United States and abroad.

The constrained maximization theory does have critics. For example, General
Electric (GE) chief executive officer (CEO) Jeffrey Immelt believes that alterations
are needed. GE is the world’s most valuable company, and it has an excellent
reputation. Immelt tells his management team that value and reputation go hand in
glove—having a good reputation with customers, suppliers, employees and
regulators is essential if value is to be maximized. According to Immelt, “The
reason people come to work for GE is that they want to be part of something that is
bigger than themselves. They want to work hard, win promotions and receive stock
options. But they also want to work for a company that makes a difference, a
company that’s doing great things in the world. . . . It’s up to GE to be a good
citizen. Not only is it a nice thing to do, it’s good for business.”

This is a new position for GE. Immelt’s predecessor, Jack Welch, focused on
compliance—like Citigroup’s Prince, Welch believed in obeying rules pertaining
to the environment, employment practices, and the like, but his goal was to
maximize shareholder value within those constraints. Immelt, on the other hand,
thinks it’s necessary to go further, doing some things because they benefit society,
not just because they are profitable. But Immelt is not totally altruistic—he thinks
that actions to improve world conditions will also enhance GE’s reputation,
helping it attract top workers and loyal customers, get better cooperation from
suppliers, and obtain expedited regulatory approvals for new ventures, all of which
would benefit GE’s stock price. One could interpret all this as saying that the
CEOs of both Citigroup and GE have stock price maximization as their top goal,
but Citigroup’s CEO focuses quite directly on that goal while GE’s CEO takes a
somewhat broader view.

1 “Tough Questions for Citigroup’s CEO,” Fortune, November 29, 2004, pp. 114–122.
2 Marc Gunther, “Money and Morals at GE,” Fortune, November 15, 2004, pp. 176–182.

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