A strategic response to Friedmans critique

of business ethics
Scott Gallagher

Scott Gallagher is an Assistant

Professor at James Madison
University in Harrisonburg,
Virginia. This article is a result of
discussions with his strategic
management and international
management students, as well
as colleagues and managers.
He has published articles on
strategic alliances and
standards-based industries in a
number of publications.
E-mail: gallagsr@jmu.edu

n 1970 Nobel Prize-winning economist Milton Friedmans[1] article A Friedman

doctrine: the social responsibility of business is to increase its profits appeared in the
New York Times Magazine. While apparently written with a focus on charitable giving by
firms, Dr Friedman argued that:

. . . there is one and only one social responsibility of business to use its resources and engage in
activities designed to increase its profits so long as it stays within the rules of the game, which is to
say, engages in open and free competition without deception or fraud (Friedman, 1970, p. 125).

Reiterated by Friedman many times since, this powerful critique has hung over discussions
of corporate social responsibility and business ethics ever since (Friedman, 1998, 2002).
While the experiences of WorldCom and Enron may appear to be prima facie evidence that
increased attention to business ethics is needed, the recent successful legal proceedings
against officers of these companies suggest that their conduct was in fact illegal, not just
unethical. Therefore, these examples do not detract from Friedmans position since the
illegal actions perpetrated by these firms executives are in violation of his standard.
Perhaps Friedmans argument has such power because it is tied so closely to the generic
mission statement of firms to maximize shareholder value. Widely taught in business
schools, this mantra . . . dominated management thinking during the nineties . . . and
remains popular to this day (Bossidy and Charan, 2004, p. 62; Ghoshal, 2005). Friedmans
argument also reinforces most managers beliefs that they are there to focus on the returns to
the firm, a belief that can be further reinforced if they are rewarded via stock options or
grants. In addition, the argument has strong institutional appeal because shareholders are
the legal owners of the firm and strong practical appeal because profitability is the
foundation for firm success. Finally, and in fairness to Friedman, there is nothing wrong with
profits. Profits are clearly socially beneficial since outcomes such as greater employment
and higher wages frequently derive from them.
Friedmans critique also possesses great simplicity and clarity, especially in comparison to
the various ways of knowing, models of ethical conduct, and models of thinking through
ethical problems that often embody a discussion of business ethics[2]. While these
frameworks are theoretically sound, one can only wonder at the probability of their being
retained by managers as they go forward with their duties. In comparison to Friedmans clear
guidance for managers, such frameworks are quite ponderous when confronting business
dilemmas.
This essay is an effort to articulate a response to Friedman based on ideas surrounding
strategic management. Strategic management, with its frameworks for internal and external
analysis and focus on why firm performance differs, offers a solid base to respond to the
clarity and applicability of Friedmans position. Equally important, it provides a foundation
through strategic planning for raising issues that highlight ethical considerations.

DOI 10.1108/02756660510633028

VOL. 26 NO. 6 2005, pp. 55-60, Q Emerald Group Publishing Limited, ISSN 0275-6668

JOURNAL OF BUSINESS STRATEGY

PAGE 55

 Strategic management, with its frameworks for internal and

external analysis and focus on why firm performance differs,
offers a solid base to respond to the clarity and applicability
of Friedmans position.

Responses to Friedman co-option and assaults

Direct responses to Friedman, at least as they have appeared in business related outlets,
have been quite limited. Many responses attempt to co-opt Friedman by arguing that firms
that behave ethically will gain considerable amounts of good will from customers and
thereby have superior performance over the long term. While there is some historical
evidence for this co-option approach, e.g. Fords success with the five-dollar day, research
has been mixed (e.g. McWilliams and Siegel, 2000) and this argument has many problems.
First, firms often engage in unethical conduct because doing so is a way to enhance their
performance. If societys ethical norms were not in occasional conflict with capitalist
economic systems, then there would not be any need for a subject called business ethics
nor much discussion of corporate social responsibility. Second, a simple survey of who
knows of an ethical firm and who has bought products from this firm because they were
ethical given to any class or group of executives will quickly reveal not many people are
aware of ethical firms and even fewer patronize them because of their ethics. Finally, surveys
of the most respected or ethical firms reveal considerable variance in their populations from
year to year. Enron and WorldCom were both highly lauded at one time in rankings such as
Fortunes Most Admired Companies while WorldCom even cracked the top 60 in the 2001
corporate reputation survey conducted by Harris Interactive[3].
It seems a mistake to argue ethics on these terms. By definition ethics generally refers to a
system of moral values that may differ from the incentives of economic systems. Ethics are a
response to Socrates famous question, How do you want to live? Economic systems are a
part of an answer to Socrates, but are generally evaluated based on how they aid a society in
efficiently allocating scarce resources. Living within a system that efficiently allocates
resources is certainly admirable, and capitalism is great at this, but economic efficiency is
not the sum total of our lives. Therefore, the evaluation of an ethical system needs a broader
metric for evaluation and attempting to argue for ethics, business or otherwise, on the narrow
basis of economic return is doomed to failure.
As an advocate of political, human, and economic freedom, Friedman would agree with this
line of thought (Friedman, 1991). Voluntary exchange is at the core of his philosophy. This is
why free political systems that enact laws for society, including laws like no slavery, are so
important. Friedman would correctly point out that his critique includes obeying the law and
so remains as a perfectly viable ethical standard for businesses.
Perhaps this is why direct assaults on Friedman from ethics writers have not met with much
success. For example, Robert Almeder (1980) attempts to equate Friedmans position with
arguments concerning killing an innocent human being for financial reward. Examples
Almeder cites include the discharge of carcinogens into the environment and advertising
cigarettes. But these arguments fade in power upon reflection. For example, by driving to
work I, too, discharge carcinogens into the environment. Is driving to work therefore
unethical? While it may be unwise for me to smoke (an implicit endorsement) is it really
unethical? Such arguments may strike managers as not applicable to the obvious reality of
their lives or worse, shrill.
A different approach is needed. As noted earlier, if behaving ethically was immediately
rewarding economically or obvious, there wouldnt be a need for business ethics. Barlett and

PAGE 56 JOURNAL OF BUSINESS STRATEGY VOL. 26 NO. 6 2005

Preston (2000), writing in the Journal of Business Ethics, suggest that managers dont view
decisions as ethical or unethical they view them in terms of success and failure, the need is
for long-term vision. The fact that ethical decisions in business are easy or obvious is clearly
a myth (Trevino and Brown, 2004). It would seem scholars could better serve managers if
they acknowledged this and, rather than invoking cliches such as do the right thing,
helped managers with the conflict and complexity of ethical issues in business. The simplest
way to do this seems to be by encouraging a long-term view of the implications of decisions
inside firms (Barlett and Preston, 2000). The question then becomes how to motivate and
bring forward that long-term view, especially against the never-ending pressure for earnings
and earnings growth in publicly traded companies.
This tension between a long-term view and the need for earnings growth is what viewing
ethical behavior as a strategic shock absorber can help offset. Given the amounts of money
involved, I believe it is impressive how honest most business people are. The fact that stories
such as accounting fraud are still news is evidence that these are not common events. In
addition, firms clearly care about ethics. Many firms have ethical codes of conduct and,
while Enrons may have been only lip service, Boeing was quite serious about theirs, as
evidenced by the resignation of their CEO for violating it (Lunsford et al., 2005). This article
assumes most people are honest and when confronted with opportunities to enhance their
personal, division, or firms performance by chiseling on their ethical beliefs just need a way
to articulate their gut feelings about it into a convincing business argument. This article
aims to help them by viewing ethical behavior as a strategic shock absorber or social
insurance for a firm.

Ethical behavior as a strategic shock absorber

Extant strategy practice offers a potentially powerful and simple response to Friedman that
to date appears to have been overlooked. As a part of traditional strength/weakness/
opportunity/threat analysis the external environment is examined. Sociocultural norms,
defined as the shared norms and values in a society, are frequently included as a
component of the frameworks used for analyzing the external environment (e.g. Hill and
Jones, 2004; Hitt et al., 2005). Since ethics is tied to broadly accepted cultural norms for
conduct, acting ethically is a way to minimize the effects of change from the socio-cultural
environment on the firm. In short, a firm that is acting ethically serves to insulate itself from
instability caused by this external force because its conduct is already in accord with
existing socio-cultural norms. Therefore, firms where managers act ethically are better able
to gain a sustainable competitive advantage because their conduct and behavior is tied
more closely to the social macro environmental force. Further, in democracies, the
socio-cultural environment is tied to the political/legal environment through elections and
peer jurors. Therefore, managers for firms who act ethically, i.e. in accordance with the
shared norms and values of society, are less likely to get blindsided by changes in these
environments, especially when social changes eventually show up in mandated legal
changes, e.g. the Sarbanes-Oxley Act of 2002.
It is this aspect of insulating the firm against change that offers a useful response to
Friedman and provides a real reason to behave ethically rather than simply engaging in
ethical marketing, image enhancement, or paying only lip service via empty codes of
conduct. Laws, especially in the USA, are not stable. So a firm operating within the law but in
an unethical manner can see its business destroyed as laws come to reflect social norms.
Since by definition social norms are aligned with ethical behavior, ethical firms are more
secure, subject to less risk, thereby less frequently compelled to change their policies and
procedures, and can therefore expect higher returns.

The fact that ethical decisions in business are easy or obvious

is clearly a myth.

VOL. 26 NO. 6 2005 JOURNAL OF BUSINESS STRATEGY PAGE 57

Laws change, so why be ethical, why not wait for the law? The issue is that waiting for the law
may be too late. Cigarette firms face decades of billion dollar payouts for activities they did
that were perfectly legal at the time. A minority of executives acting unethically inside a firm
are potentially gambling the firms very survival, as the collapse of Arthur Andersen
underscores. Unethical behavior by a small minority of managers at that firm destroyed the
financial security of hundreds of other honest Arthur Andersen partners[4].
The risks of only doing what the law requires are further exacerbated by torts, or implicit
duties, in countries such as the USA with strong common law traditions. The legal system in
the USA offers numerous examples to illustrate the pitfalls of unethical, rather than blatantly
illegal, behavior. For example consider the recent trouble conversions of traditional pension
plans to cash balance plans has caused companies (Schultz, 2003). This attempt to
reduce pension costs clearly discriminated against a firms oldest and presumably most
loyal workers. Judges and jurors have had no compunction about penalizing companies
acting in this manner. Cigarette and asbestos manufacturers may be additional examples of
firms that were clearly operating within the law who were later blindsided by ethical
missteps. So acting within the law, even upholding its spirit while avoiding fraud and
deception, is not always enough because aspects of the law are tacit and subject to change.

Implications and examples

Friedmans critique goes to the heart of the firm and if left unchallenged, due to its
applicability, simplicity, intuitive appeal, and congruence with the norms and expectations of
life in a capitalist economic system, could easily dominate managerial decision making. It
can provide the legitimacy for questionable activities that will generate considerable wealth.
Those calling for increased attention to business ethics need to offer managers a coherent
response to this elementary 35-year-old challenge.
Imagine being present in the Enron boardroom discussing the creation of an off balance
sheet entity that will boost your firms reported financial performance. Your lawyers and
accountants say it is okay (in fact, they might have even sold your firm the idea!), so why
shouldnt you create considerable wealth for yourself and your shareholders by setting up
entities that appear to be independent on the balance sheet? It may not feel right in your
gut but what strategic argument could you use against this? By clearly linking ethics to
other strategic analysis frameworks the approach of ethics as insurance offers an integrated
response to bringing forward the value of a long-term view and providing a clear answer to
questions like these. Such consideration could be integrated with a firms strategic planning
functions. Even if a firms strategic plan sits on a shelf, the exercise of examining the
political/legal environment and considering its long-term direction and consequences can
help bring forward a long term view further encouraging and facilitating the articulation of the
value of ethical conduct.
A dramatic example of the potential power of this approach is exhibited by the disparate
impact of New York Attorney General Eliot Spitzers probes into the insurance industry.
Marsh McLennan and American Insurance Group (AIG) found themselves (and their stock
price) in tatters. Yet Berkshire Hathaway was partner for some of the AIG transactions and it
has not suffered nearly as much financially or otherwise (Karmin, 2005). While Berkshire
Hathaway is more diversified than AIG, it also has a CEO, Warren Buffett, who has a strong
ethical reputation, including some dramatic ethical statements during his running of
Salomon Brothers in the early 1990s (Eisinger, 2005)[5].
This example also highlights how this argument goes beyond pre-emption. Buffett and
Berkshire Hathaway didnt know where the next ethical challenge or lapse was going to
come from. Buffett acted ethically for its own sake. Similar experiences have been noted at
General Electric under Jack Welch, where a large number of embarrassing incidents, e.g.
overcharges to the Defense Department, a rigged crash test by NBC News, and $350 million
in phony profits at its Kidder Peabody finance unit and even embarrassing personal
disclosures that resulted from Welchs divorce have not harmed his or GEs reputation
(Slater, 1999; Murry et al., 2002). By acting ethically, and encouraging ethical behavior by

PAGE 58 JOURNAL OF BUSINESS STRATEGY VOL. 26 NO. 6 2005

others (including their firms reward systems) these icons of US business could be confident
that ethical conduct would help shield themselves and their company from future
challenges.
Looking forward, there are many potential examples where ethical behavior may serve firms
well. Given the inevitability of side effects, pharmaceuticals may be an especially apt
industry in which ethical behavior is important. Consider the recent controversy over the
COX-2 pain inhibitors that were marketed by Pfizer and Merck. Merck voluntarily recalled
Vioxx while Pfizer kept Celebrex on the market. While it is clear that the data each company
had on the side effects of their drugs differed, as court proceedings begin it will be
interesting to see if the voluntary action by Merck helps that firm.
Another example is a utility company that has recently become much more aggressive about
collecting on its accounts (Smith, 2005). Will people be as sympathetic of firms penalizing
people and using as heavy-handed collection tactics for electric bills as for credit card
debts? Or consider the recent news that hedge funds are starting to offer preferential
redemption options for their wealthiest clients (Mollenkamp and Reilly, 2005). While hedge
funds have benefited from not being as strictly regulated as mutual funds, recent innovations
have allowed smaller investors access to them by cutting minimum investments from
$1,000,000 to $20,000 (Zuckerman, 2005). I would expect that preferential treatment for an
already privileged class to a core function like the return of capital could be viewed by many
as unethical and easily result in increased regulation for this industry.

Conclusion

Keywords:
Business ethics,
Governance,
Social responsibility,
Economic theory

So whats the point? Managers inside firms should act ethically because if their actions do
not align with societys broader view of ethical behavior the entire organization is at risk. The
legal system is the most obvious but not the only way that failing to conform to ethical norms
can cause problems for firms. For example the transparency of corporate activities appears
to be increasing, when coupled with advances in communications such as the internet, and
company reputations may be especially vulnerable to unethical activity. Managers cannot
afford to wait for laws to tell them what is ethical because legal entrepreneurs (or aspiring
attorneys general) are always looking for new torts to ensnare them and by the time new laws
arrive it may be too late for the firm and its incumbent managers. After all, Florida changed its
laws retroactively to enable its Medicaid lawsuits against cigarette companies (Levy, 1997).
Acting ethically therefore becomes one of the best insurance policies a company can have. I
firmly believe that almost all practicing managers are honest individuals. In addition to
potential reputation effects, ethical behavior by a firms managers serve as a shock absorber
from a wide range of socio-cultural related threats, not only to firm performance, but firm
existence.

Notes
1. Friedman is most famous for his work on the monetary theory of economics for which he won the
Nobel Prize in 1976. In addition to his work in theoretical economics he has written numerous books
and articles on issues of freedom and related public policy issues.
2. See for example, Carrol (1979) that despite being only eight pages provides three dimensions and
multiple categories per dimension, which is a lot harder to remember and implement than, maximize
profits while following the rules of the game. Carrol (2004) discusses broader aspects of corporate
social responsibility.
3. The Fortune listings have come out annually since 1981 in February. The Harris Interactive poll
results are published by the Wall Street Journal.
4. Ironically, starting in the late 1980s, Arthur Andersen was one of the strongest advocates of business
ethics and teaching business ethics. See, Sims, R. (2002), Teaching Business Ethics for Effective
Learning, Quorum Books, Westport CT.
5. Buffetts most famous ethical statement at Salomon was a message he sent to his employees, Lose
money for the firm and I will be understanding; lose a shred of reputation for the firm, and I will be
ruthless.

VOL. 26 NO. 6 2005 JOURNAL OF BUSINESS STRATEGY PAGE 59

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