A statement that I've heard over and over, is that U.S. companies are legally obligated to maximize profits for shareholders, and that this explains why companies act in socially irresponsible ways.
In this speech at Netroots Nation, former U.S. Senator Al Franken said:
it is literally malfeasance for a corporation not to do everything it legally can to maximize its profits.
I think I may have read somewhere that this is a myth, and unfortunately pervasive in many companies and by the public.
No. Because the idea itself is too poorly defined and naive interpretations are often bad for shareholders in practice (and no law demanding it exists)
If the legal obligation to maximize profit for shareholders existed, we would have to develop a good definition of how it is to be measured. Alas, there isn't even a unique way to summarize a stream of known cash payments over time into a single current value (the summarized by Wikipedia).
Many of the issues come down to a judgement call about making a costly investment now for higher profits in the future or just giving the cash to shareholders instead. This is a hard matter of judgement and coping with uncertainty in the future.
The Shareholder Value movement has been influential in promoting the idea that cashflow to shareholders should be the focus of senior management in quoted companies. The movement has led to some beneficial changes in business practice, but has also led many leaders to become overly obsessed with their share prices. As John Kay (a British economist and commentator) has pointed out:
Managers who focus closely on the stock price, whether by inclination or because they have incentives to do so, will often fail to serve the best interests even of their stockholders.
In another of his regular columns in the Financial Times he describes his own journey with the idea of shareholder value:
In my academic life, I taught the standard concepts of modern economic theory, based on efficient markets populated by maximising agents. Yet, as I saw more of successful businesses, I understood that they didn’t maximise anything. Such businesses were complex political organisms: they contained and were influenced by diverse individuals and groups with diverse goals, and the effective manager was someone who could mediate between these conflicting forces. If these companies talked about shareholder value – and increasingly they did – it was an instance of Franklin’s Gambit, a legitimising rhetoric rather than a real guide to action.
And the more shareholder value became a guide to action, the worse the outcome. On the board of the Halifax Building Society, I voted in 1995 for its conversion to a “plc”. We would allow the company to pursue the goal of maximising its value untrammelled by outmoded concepts of mutuality: in barely a decade, almost every last penny of that value was destroyed. In 1996, as my thoughts on this began to form, I went to the CBI annual conference and described how ICI, for decades Britain’s leading industrial company, had recently transformed its mission statement from “the responsible application of chemistry” to “creating value for shareholders”. The company’s share price peaked a few months later, to begin a remorseless decline that would lead to its disappearance as an independent company.
...These unanticipated results reflected the profit-seeking paradox, well described in James Collins and Jerry Porras’s fine book Built to Last: the most profitable companies were not the most profit-oriented.
As he summarizes:
the idea that good decisions are the product of orderly processes – is more alive than ever in public affairs. ...There is not, and never will be, such a science. Our objectives are typically imprecise, multifaceted and change as we progress towards them – and properly so. Our decisions depend on the responses of others, and on what we anticipate these responses will be. The world is complex and imperfectly known, and this will remain true however much we analyse it.
And this summary explains why the idea of "maximizing" profit is not a sensible objective in itself: the world is too complex and no formula can reduce it to a meaningful value.
Update
A recent Washington Post blog includes some useful references and commentary. For example, the blog argues:
this supposed imperative to “maximize” a company’s share price has no foundation in history or in law. Nor is there any empirical evidence that it makes the economy or the society better off. What began in the 1970s and ’80s as a useful corrective to self-satisfied managerial mediocrity has become a corrupting, self-interested dogma peddled by finance professors, money managers and over-compensated corporate executives.
And:
There are no statutes that put the shareholder at the top of the corporate priority list. In most states, corporations can be formed for any lawful purpose. Cornell University law professor Lynn Stout has been looking for years for a corporate charter that even mentions maximizing profits or share price. She hasn’t found one.
Nor does the law require, as many believe, that executives and directors owe a special fiduciary duty to shareholders. The fiduciary duty, in fact, is owed simply to the corporation, which is owned by no one, just as you and I are owned by no one — we are all “persons” in the eyes of the law. Shareholders, however, have a contractual claim to the “residual value” of the corporation once all its other obligations have been satisfied — and even then directors are given wide latitude to make whatever use of that residual value they choose, as long they’re not stealing it for themselves.
This provides a relatively concise summary of the case in the USA.
Second Update
A The Shareholder Value Myth, on the topic).
Summarising some of the previously discussed analysis she argues:
Shareholder primacy theory is suffering a crisis of confidence. This is happening in large part because it is becoming clear that shareholder value thinking doesn’t seem to work, even for most shareholders.
On the core idea that shareholders "own" the firm:
Although laymen sometimes have difficulty understanding the point, corporations are legal entities that own themselves, just as human entities own themselves. What shareholders own are shares, a type of contact between the shareholder and the legal entity that gives shareholders limited legal rights. In this regard, shareholders stand on equal footing with the corporation’s bondholders, suppliers, and employees, all of whom also enter contracts with the firm that give them limited legal rights.
On the idea that shareholders are the residual claimants of the corporation's wealth:
A more sophisticated but equally mistaken claim is the residual claimants argument. ... But the residual claimants argument is also legally erroneous. Shareholders are residual claimants only when failed companies are being liquidated in bankruptcy. The law applies different rules to healthy companies, where the legal entity is its own residual claimant, meaning the entity is entitled to keep its profits and to use them as its board of directors sees fit. The board may choose to distribute some profits as dividends to shareholders. But it can also choose instead to raise employee salaries; invest in marketing or research and development; or make charitable contributions.
On the legal duties of directors:
Provided directors don’t use their corporate powers to enrich themselves, a key legal doctrine called the “business judgment rule” otherwise protects them from liability.
The business judgment rule ensures that, contrary to popular belief, the managers of public companies have no enforceable legal duty to maximize shareholder value.
She further argues that the idea of shareholder value is itself incoherent and there is little or no evidence that firms who have pursued it have performed well.
In short, shareholder value is a bad theory of how to manage the firm; a legal fiction; and a stick used by anti-business activists to demonise capitalist activity.
Not directly, but often conditions surrounding corporations lead to this obligation
I've been searching for the answer to this question some time ago, and I found this wonderful LinkedIn thread on the exactly the same issue. So while I'm no lawyer, let me try to explain my findings:
The situation in the US is like this. First, there is a business judgement rule, which says:
directors of a corporation . . . are clothed with [the] presumption, which the law accords to them, of being [motivated] in their conduct by a bona fide regard for the interests of the corporation whose affairs the stockholders have committed to their charge
This implies that directors must do the best for the corporation. Corporations, in turn, seek to maximize the value for the shareholders because if they don’t, the shareholders will exercise their right to replace management. In 99% of the cases, all what the shareholders want is profit (especially in listed companies, where most shareholders don't really say anything at all). So in the end, you get the legal obligation from directors to maximize profit.
However, if shareholders agreed that it's not only profit that matters, you get a different picture.
You will find further arguments in the thread linked above, yet most of it will be opinions without references.
The exact situation is that
This is built into most legal systems, and is intended to prevent directors managing companies for their own benefit, rather than the owners or shareholders. However it doesn't have to be interpreted narrowly, such as maximizing share price at a given time. Also if a company is explicitly set up for some purpose other than maximizing profit then the directors must work towards that purpose. In many jurisdictions it is explicitly written into law that directors must take into account factors other than profit. For example the UK Companies Act 2006 lays down specific factors that a director must take into account in their decisions.
The short answer is no. They don't get punished for not maximizing shareholder value. But it is true that maximizing value needs to be their goal and they may not be negligent in the pursuit of that goal.
The reason the law is this way is that everyone else who deals with a corporation has their own legal rights: Suppliers, employers, customers, etc.
If the law was not this way then stockholders would have no recourse.
As found here
A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end, and does not extend to a change in the end itself, to the reduction of profits, or to the nondistribution of profits among stockholders in order to devote them to other purposes.
Short answer is NO corporations enjoy the same corporate personhood (Wikipedia has a great write up of this already) While this idea is unpopular it has been upheld several times and is considered the current law of the land.
If a company is publicly traded then the SEC does have some requirements mostly that require accurate reporting but none that require the company actually attempt to make a profit.
Most shareholders want a stated goals. Though no law actually enforces that the company persue those goals nor does the law penalize those companies for not attempting to persue them so long as they do not attempt to represent that they are(commit fraud).
A perfect example of this would be the American Red Cross it is a business lead by a CEO but operates as a non profit entity. While there are some specific things that the Red Cross has been chartered to do by law it operates independently and manages its finances as a business.
There are two problems with the statement.
First, the company has a purpose and it has to follow this purpose. The purpose can be making money, but it can be something else. Like Twitter's purpose might be to protect freedom of speech.
Second, even if the goal is to maximise profit, shareholders might be interested in maximising short term profit, which is not the same at all. It will often be in the long term a much better strategy to produce good products at good prices instead of maximising profit by ripping of its customers and destroying its reputation.
