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The Normative Theories of Business Ethics: A Guide for the Perplexed

Published online by Cambridge University Press:  23 January 2015

John Hasnas
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Abstract:

The three leading normative theories of business ethics are the stockholder theory, the stakeholder theory, and the social contract theory. Currently, the stockholder theory is somewhat out of favor with many members of the business ethics community. The stakeholder theory, in contrast, is widely accepted, and the social contract theory appears to be gaining increasing adherents. In this article, I undertake a critical review of the supporting arguments for each of the theories, and argue that the stockholder theory is neither as outdated nor as flawed as it is sometimes made to seem and that there are significant problems with the grounding of both the stakeholder and social contract theory. I conclude by suggesting that a truly adequate normative theory of business ethics must ultimately be grounded in individual consent.

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Articles
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Business Ethics Quarterly , Volume 8 , Issue 1 , January 1998 , pp. 19 - 42
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Copyright © Society for Business Ethics 1998

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References

Notes

1 Apologies to Maimonides.

2 J.D., Ph.D., Philosophy, Duke University, LL.M. Temple University School of Law. Assistant General Counsel, Koch Industries, Inc., Wichita, Kansas. This paper has greatly benefitted from the thoughtful comments and suggestions of Thomas Donaldson, Dennis Quinn, and Tom Beauchamp of Georgetown University, Thomas Dunfee of the Wharton School, Thomas Jones of the University of Washington, Ian Maitland of the University of Minnesota, Jeff Nesteruk of Franklin & Marshall College, Douglas Den Uyl of Bellarmine College, Patricia Werhane of the Darden Graduate School of Business Administration, Ann C. Tunstall, and my anonymous reviewers. I am sincerely grateful to each of them for their assistance. An earlier version of this article was presented as part of the John F. Connelly Business Ethics Seminar Series at Georgetown University.

3 For a famous example of this, see Andrew Stark, “What’s the Matter with Business Ethics?”, 71 Harv. Bus. Rev. 38 (1993). See also Thomas Donaldson and Thomas W. Dunfee, “Integrative Social Contracts Theory: A Communitarian Conception of Business Ethics,” 11 Econ. & Phil. 85, 87 (1995).

4 I am employing this phrase in an effort to avoid the confusion engendered by referring to strictly normative theories as “theories of corporate social responsibility.” The latter phrase has been used to refer to not only normative theories, which attempt to identify the philosophically verifiable ethical obligations of businesses and business persons, but also to theories that are either purely or partially descriptive or instrumental in nature, such as those that focus on businesses’ or business person’s responsiveness to societal expectations or demands. Indeed, historically speaking, the concept of corporate social responsibility arose as a response to an increasing level of criticism of the business system in general and the power and privilege of large corporations in particular, see Thomas M. Jones. “Corporate Social Responsibility: Revisited, Redefined,” 22 Cal. Bus. Rev. 59, 59 (1980), and, to some extent, as a reaction against the stockholder theory, one of the normative theories to be examined in the body of this article. As a result, the theories of corporate social responsibility should probably be seen as a genus of which what I am calling the normative theories of business ethics are a species.

5 Evidence for this may be found not only in the inordinately large percentage of business ethics journal articles that discuss the stakeholder theory favorably, but in the increasing number of textbooks that are being written from the stakeholder perspective. See, e.g., Ronald M. Green, The Ethical Manager (1994), Joseph W. Weiss, Business Ethics: A Managerial, Stakeholder Approach (1994), Archie B. Carroll, Business and Society: Ethics and Stakeholder Management (1996).

6 Consider, for example, the recent special issue of Business Ethics Quarterly devoted to the social contract theory. 5 Business Ethics Quarterly 167 (Thomas W. Dunfee, ed., 1995).

7 In this article, I intentionally speak in terms of ‘the stockholder theory’ rather than ‘agency theory’ to emphasize that I am discussing a normative theory. ‘Agency theory’ seems to be used ambiguously to refer to both the attempt to produce an empirical description of the relationship between managers and stockholders and the normative implications that would flow from such a relationship. See Norman E. Bowie and R. Edward Freeman, “Ethics and Agency Theory: An Introduction,” in Ethics and Agency Theory 3, 3-4 (Norman E. Bowie and R. Edward Freeman, eds., 1992). In order to avoid this ambiguity in the present context, I employ the label ‘stockholder theory’ to indicate that I am referring strictly to a theory of how businesses or business people should behave.

8 Historically, the normative theories of business ethics grew out of the literature on corporate social responsibility. As a result, they are often expressed as though they apply only to corporations rather than to businesses generally. This is certainly the case with regard to the stockholder theory. To be adequate, however, a normative theory of business ethics should apply to businesses of all types.

For ease of expression, I intend to follow the convention and employ the terminology of the corporate form in my representation of the theories. However, I will attempt to show how each of the theories may be generalized to apply to other forms of business as well. See infra notes 24, 45, 64.

9 I wish to emphasize again that the stockholder theory is a normative and not a descriptive theory. As such, it asserts not that managers are, in fact, the agents of the stockholders, but that they are ethically obligated to act as though they were.

10 Milton Friedman, Capitalism and Freedom 133 (1962). I should point out that Friedman does not always describe the constraints on the pursuit of profit this precisely. Often, he merely states that businesses should “make as much money as possible while conforming to the basic rules of society, both those embodied in law and those embodied in ethical custom.” Milton Friedman, “The Social Responsibility of Business is to Increase Its Profits,” N.Y. Times Magazine, September 13, 1970 at 32-33. Of course, when stated this broadly, Friedman’s injunction becomes a triviality asserting nothing more than that one should pursue profits ethically. Although this has been the source of much criticism of Friedman’s particular expression of the stockholder theory, it need not concern us in the present context. The more specific statement given in the text does define a substantive position worthy of serious consideration, and so, that is the formulation that will be used in this article.

11 The additional restriction of Friedman’s formulation that requires managers to engage solely in open and free competition is usually ignored. In today’s regulatory environment, it is not regarded as unethical to lobby the government for favor. In many cases, such activities are necessary as a matter of corporate self-defense.

12 It may be accurate to characterize the stockholder theory as proposing an “ethical division of labor.” According to the stockholder theory, the nature of the business environment itself imposes a basic duty of honest dealing on business people. However, the theory also claims that for there to be any more extensive restrictions on managers, it is the job of society as a whole to impose them through the legislative process.

It is, of course, true that this approach defines managers’ ethical obligations partially in terms of their legal obligations and implies that their ethical obligations will change as the legislation that defines and regulates the business environment changes. This, in turn, implies that the stockholder theory is not self-sufficient, but is dependent upon the political theory (which delimits the scope of the state’s power to legislate) within which it is embedded. This dependence does not render the theory unintelligible, however. At any particular point in time, the theory can be understood as asserting that a business or business person must refrain from engaging in deceptive practices and violating the laws of the land as they exist at that time.

13 It must be kept in mind at all times that the version of the stockholder theory that asserts that the manager is ethically obliged to increase the company’s profits is true only for those for-profit companies in which it is reasonable to interpret the stockholders wishes as the maximization of profit. Whenever the stockholders have indicated that they wish their resources to be used for other purposes, the stockholder theory requires managers to attempt to fulfill those purposes, even if doing so comes at the expense of profits.

14 See, e.g., Dennis P. Quinn and Thomas M. Jones, “An Agent Morality View of Business Policy,” 20 Acad. Mgmt. Rev. 22, 24 (1995); William M. Evan and R. Edward Freeman, “A Stakeholder Theory of the Modern Corporation: Kantian Capitalism,” in Ethical Theory and Business 75, 77 (Tom L. Beauchamp and Norman E. Bowie, eds., 4th ed., 1993).

15 Adam Smith, The Wealth of Nations, bk. IV, ch. 2, para. 9.

16 This argument can be expressed in more philosophically sophisticated language by stating that one who breaches an agreement that induced another to deal with him or her is treating the other merely as a means to his or her own ends, and is thus violating the Kantian principle of respect for persons.

It is useful to note that Friedman himself offers this deontological argument in support of the stockholder theory, not the utilitarian argument described previously. See Milton Friedman, The Social Responsibility of Business is to Increase Its Profits, supra note 10. See also Friedman, Capitalism and Freedom, supra note 10, at 135.

17 See Evan and Freeman, supra note 14, at 76-7; Thomas Donaldson and Lee E. Preston, “The Stakeholder Theory of the Corporation: Concepts, Evidence, and Implications,” 20 Acad. Mgmt Rev. 65, 81-2 (1995).

18 Thomas Donaldson, The Ethics of International Business 45 (1989).

19 Robert C. Solomon, Ethics and Excellence 45 (1992).

20 Evan and Freeman, supra note 14, at 77-8.

21 See James D. Gwartney and Richard E. Wagner, “Public Choice and the Conduct of Representative Government,” in Public Choice and Constitutional Economics 3, 23 (James D. Gwartney and Richard E. Wagner, eds., 1988).

22 This highly telescoped formulation of what is, in truth, a considerably more sophisticated consequentialist argument is employed strictly in the interest of conciseness. The fuller articulation it deserves must await a more detailed consideration of the stockholder theory than the present overview of the normative theories of business ethics permits.

23 For two examples, see infra p. 35.

24 As mentioned previously, see supra note 8, because of its historical association with debate over corporate social responsibility, the stockholder theory is expressed in language that suggests the corporate form, e.g., stock, stockholders. Despite this, the stockholder theory can be applied to all forms of business. In its generalized form, the theory would simply state that managers are ethically obligated to use business resources that have been advanced to them under condition that they be used for specified purposes to accomplish only those purposes. Thus, whether the managers are officers of a public corporation funded by stockholders, managing partners of a limited partnership funded by the limited partners, or sole proprietors funded by investors, they are obligated to use the business’s resources in accordance with the agreements they entered into with the stockholders, limited partners, or investors.

25 Unlike ‘agency theory,’ however, the phrase ‘stakeholder theory’ cannot be avoided.

Various attempts have been made to clarify the distinction between the normative and non-normative variants of the stakeholder theory. For example, Kenneth Goodpaster distinguishes non-normative “strategic stakeholder synthesis” from normative “multi-fiduciary stakeholder synthesis.” Kenneth E. Goodpaster, “Business Ethics and Stakeholder Analysis,” 1 Business Ethics Quarterly 53 (1991). Recently, Thomas Donaldson and Lee Preston have further clarified the situation by identifying and distinguishing three different “types” of stakeholder theory; descriptive/empirical, instrumental, and normative. See Donaldson and Preston, supra note 17, at 69-73.

For purposes of simplicity and because in this article I will not be commenting on the distinction between the descriptive/empirical and instrumental versions of the theory, I will employ the term ‘empirical’ in a generic sense to refer to the non-normative versions of the stakeholder theory.

26 See R. E. Freeman, Strategic Management: A Stakeholder Approach (1984); Donaldson and Preston, supra note 17, at 71.

27 See Evan and Freeman, supra note 14, at 76.

28 Id. at 79. See also E. Freeman and D. Reed, “Stockholders and Stakeholders: A New Perspective on Corporate Governance,” in Corporate Governance: A Definitive Exploration of the Issues (C. Huizinga, ed., 1983).

29 This corresponds to Goodpaster’s strategic stakeholder synthesis and Donaldson and Preston’s instrumental stakeholder theory. See supra note 25.

30 In stating that management must give equal consideration to the interests of all stakeholders, I am not ignoring the work being done to distinguish among different classes of stakeholders. See, e.g., Max B.E. Clarkson, “A Stakeholder Framework for Analyzing and Evaluating Corporate Social Performance,” 20 Acad. Mgmt. Rev. 92, 105-8 (1995). On this point, it is essential to distinguish between the stakeholder theory as a normative theory of business ethics on the one hand and as either a theory of corporate social responsibility or a theory of management on the other. See supra note 4 and the material immediately preceding this note. For purposes of either evaluating a business’s responsiveness to societal demands or describing effective management techniques, it can make perfect sense to distinguish among different classes of stakeholders. However, given the arguments that have been provided in support of the stakeholder theory as a normative theory of business ethics (to be discussed below), it can not. The logic of these arguments, whether Kantian, Rawlsian, or derived from property rights, makes no allowance for stakeholders of differing moral status. Each implies that all stakeholders are entitled to equal moral consideration. In my opinion, this represents a major difference between the normative and non-normative versions of the stakeholder theory, and one that is likely to generate confusion if not carefully attended to.

31 Evan and Freeman, supra note 14, at 82.

32 Id. Clearly, this is Goodpaster’s multi-fiduciary stakeholder synthesis. See supra note 25.

This feature of the normative stakeholder theory immediately gives rise to the objection that it is based on an oxymoron. Given the meaning of the word ‘fiduciary,’ it is impossible to have a fiduciary relationship to several parties who, like the stakeholders of a corporation, have potentially conflicting interests. Further, even if this did make sense, placing oneself in such a position would appear to be unethical. For example, an attorney who represented two parties with conflicting interests would clearly be guilty of a violation of the canon of ethics.

This objection clearly deserves a fuller treatment than it can be given in a footnote. However, because the purpose of the present work is limited to the critical examination of the arguments offered in support of the three main normative theories of business ethics, an attempt to fully evaluate the theories’ adequacy would clearly be beyond its scope. Hence, a more detailed examination of this objection must be deferred until a later time.

33 See, e.g., Donaldson and Preston, supra note 17, at 72, who point out that in most of the stakeholder literature “the fundamental normative principles involved are often unexamined.”

34 Evan and Freeman, supra note 14. This was not the earliest attempt to provide a normative grounding for the stakeholder theory. See, e.g., Thomas M. Jones and Leonard D. Goldberg, “Governing the Large Corporation: More Arguments for Public Directors,” 7 Acad. Mgmt. Rev. 603 (1982). However, it does appear to be the first effort to derive the stakeholder theory directly from a widely accepted principle of philosophical ethics. This apparently accounts for the widespread attention it has commanded among the commentators.

35 Evan and Freeman, supra note 14.

36 Id. at 76.

37 Id. at 78.

38 R. Edward Freeman and William Evan, “Corporate Governance: A Stakeholder Interpretation,” 19 J. Behav. Econ. 337 (1990).

39 Id. at 352.

40 Id. at 353.

41 The unsupported and counter-intuitive assumption that people are ethically entitled to a say in any decision which affects their interests appears to lie at the heart of most attempts to ground the stakeholder theory, and can be found even in those that predate the ones presently under consideration. For an early example of this, consider Jones and Goldberg’s 1982 assertion that “if legitimacy centers on the consent of the governed, the legitimacy of corporate decisions made by managers would hinge on the willingness of people affected by these decisions to recognize the right of the managers to make them. Because several groups are affected by managerial decisions, legitimacy depends on acceptance of this authority by several types of ‘stake holders.’” Jones and Goldberg, supra note 34, at 606 (emphasis added).

42 Donaldson and Preston, supra note 17, at 82. The rationale underlying this claim is, at best, somewhat murky. The sentence which immediately follows it is: “Changes in state incorporation laws to reflect a ‘constituency’ perspective have already been mentioned.” Id. Professor Donaldson has assured me that this is not intended as an appeal to the ethical authority of the law, but rather to the normative reasons behind the change in the law as indicated by the article’s next sentence: “The normative basis for these changes in current mainstream legal thinking is articulated in the recent American Law Institute report, Principles of Corporate Governance (1992).” Id. However, the sections of the ALI report that the authors cite state nothing more than that corporate officials are legally permitted to take ethical considerations into account even where doing so would not enhance corporate profit or shareholder gain and that they are “subject to the same ethical considerations as other members of society.” Id. This, however, is wholly consistent with the stockholder theory which asserts that corporate managers are not only legally permitted, but ethically required to restrict the means by which they seek to carry out the instructions of their stockholder principals to those which fall within the ethical boundaries set by the law and the principles of honest dealing and open and free competition. The ALI report is indeed inconsistent with the claim that corporate managers should pursue profit by any means without regard to legal or ethical constraints. It hardly needs repeating, however, that this is not the claim made by the stockholder theory, but that of the straw man the theory’s opponents trot out to stand in its stead. At any rate, it is entirely unclear how the comments cited by Donaldson and Preston provide any support for the assertion that the stockholder theory is normatively unacceptable.

43 Donaldson and Preston, supra note 17, at 82-4.

44 Philosophers such as Robert Nozick would not accept this contention nor would anyone who argues from a classical liberal perspective. Further, as a matter of purely historical fact, the assertion is clearly false.

45 Like the other theories, the stakeholder theory is expressed in language suggesting the corporate form. However, the theory is clearly perfectly general. Whether the business concerned is a corporation, partnership, or sole proprietorship, the business’s stakeholders, those who are vital to its survival and success, can be identified. The stakeholder theory requires the managers to manage the business for the benefit of these stakeholders, regardless of the business’s form.

46 Professors Thomas Donaldson and Thomas Dunfee have recently introduced a complex and highly sophisticated version of social contract theory that they call Integrative Social Contracts Theory (ISCT). See Thomas Donaldson and Thomas W. Dunfee, “Toward a Unified Conception of Business Ethics: Integrative Social Contracts Theory,” 19 Acad. Mgmt. Rev. 252 (1994). The authors are presently in the process of developing a book length exposition of this theory. Although this theory is beyond the scope of the present work and hence will not be directly addressed, it should be noted that ISCT constitutes an attempt to marry the individual social contract theories of Donaldson and Dunfee, both of which are addressed. Therefore, to some extent, the comments made in this article may be extrapolated to apply to ISCT as well.

47 See Thomas Donaldson, Corporations and Morality, ch. 2 (1982).

48 See Donaldson, Corporations and Morality, supra note 47, at 43. The specific description of the social contract theory that follows is taken from this source.

49 Id. at 44.

50 Id. at 54.

51 Id. at 53.

52 Id. at 48-9.

53 Id. at 53. This last requirement is apparently intended as an antidiscrimination provision.

54 Indeed, many entrepreneurs forum-shop, electing to go into business in the state whose legal regime appears least burdensome to them. Such individuals would clearly be shocked to be told that regardless of which state they chose, they had agreed to abide by the restrictions described by the social contract theory.

55 Thomas Donaldson, The Ethics of International Business 56 (1989).

56 Id. at 61.

57 Id.

58 Because this version of the social contract theory appears to be based on what is essentially a Rawlsian theory of justice, this task would indeed be a formidable one. It would require an examination not only of the relative merits of a Rawlsian conception of justice as opposed to Nozickian and other conceptions, but also of whether such a conception is appropriate in the present limited realm of application. However, once consent has been abandoned as the basis for the social contract, there seems to be no avoiding this. Currently, the best that can be said about this version of the social contract theory is that it is, at most, as well established as John Rawls’ theory of justice.

59 See Thomas W. Dunfee, “Business Ethics and Extant Social Contracts,” 1 Business Ethics Quarterly 23 (1991).

60 Id. at 32.

61 Id. In fact, there is some question whether all extant social contracts are true agreements since it is claimed that consent is implied by “merely enjoying the benefits of the community or even engaging in transactions within the realm of the community.” Id. This raises the thorny problem of how one can be said to consent to an agreement without being aware one is doing so. However, because any attempt to resolve this point is beyond the scope of the current work, I will assume for purposes of the present discussion that all extant social contracts are true, consent-based agreements.

62 Id. at 33.

63 This may be an unfair characterization. The theory contemplates the possibility of one simultaneously belonging to several communities with incompatible social contracts and asserts that such conflicts must be resolved on the basis of an unspecified “priority rule.” (It should be noted that, like the filtering test discussed below, as long as the priority rule remains unspecified, it is impossible to fully evaluate this theory.) However, the theory does not seem to address the situation in which one has entered into incompatible agreements within a single community. It is the latter point that I am presently addressing.

64 As was the case with the stakeholder theory, although the social contract theory is sometimes expressed in the language of the corporation, it clearly applies to businesses generally. Under a social contract approach, the members of society authorize the existence of not merely corporations, but businesses of any form. Thus, all businesses are bound by the terms of the social contract. As a matter of fact, Donaldson’s early version of the theory was expressed in perfectly general terms, speaking not about corporations, but about “productive organizations.”

65 I have argued in the body of this article that there is, in fact, no ethical entitlement to have a say in any decision that affects one’s interests and that the attempts of stakeholder theorists to derive one from Kant’s principle of respect for persons, Rawls’ theory of justice, and a contemporary theory of property rights have been unsuccessful. However, assuming arguendo that the stakeholder theorists are correct and that such an entitlement does exist, it would certainly imply that individuals are ethically entitled to control their own lives.

66 Robert Hessen, “A New Concept of Corporations: A Contractual and Private Property Model,” 30 Hastings L.J. 1327, 1330 (1979).

67 This is as true of corporations as it is of any other type of business organization. The claim that a corporation is a “creature of the state,” endowed by the government with special privileges not available to other freely-organized forms of business is asserted so frequently that it is typically regarded as a truism. That this is not, in fact, the case, is amply demonstrated by Robert Hessen in the article cited in the immediately preceding note. I heartily recommend it to those unfamiliar with the history and law of corporations.

I should add that I am not claiming either that the idea of a business as a network of contracts is a new or original insight (its long lineage is indicated by the source I cite in support of it in the immediately preceding note) or that it commands universal acceptance. I am suggesting, however, that it is an accurate characterization of the ethical nature of business, and further, that support for it can be found in the centrality of consent to each of the three previously examined theories. I am also suggesting that it is an observation that deserves more consideration than it has yet received from those working on the normative theories of business ethics.

68 In this context, I am clearly referring to actual, as opposed to hypothetical or tacit, consent. Hypothetical or tacit consent is, in fact, not consent at all, but the presumption of consent where none has actually been given. It follows that in describing a business as a voluntary association of individuals united by a network of contracts, the contracts being referred to are actual interpersonal agreements, not hypothetical social contracts.

69 It may be more precise to say that the stockholder theory fails to address the obligations arising out of those agreements that are not inconsistent with the managers’ antecedent agreement with the stockholders. However, it is at least arguable that what should be done when managers have made inconsistent commitments is itself an issue that would have to addressed by an adequate normative theory of business ethics.

70 This may well be an understatement. Given the wide variety of enterprises that are described by the word ‘business,’ from the smallest closely-held family business to the largest publicly-traded multinational conglomerate, and from the most mission-oriented nonprofit to the most bottom-line-oriented entrepreneurial venture, it is reasonable to doubt whether this term has a definite enough referent for the construction of a general normative theory of business ethics to even be possible. If it does not, we will simply have to content ourselves with the recognition that ethically proper behavior necessarily depends on the particular agreements the actor has entered into, and leave it at that.

71 Actually, some promising preliminary steps in meeting this challenge have already been taken by Professors Dennis Quinn and Thomas Jones in their article An Agent Morality View of Business Policy, supra note 14. This may serve as a useful starting point for those who believe that an adequate general normative theory of business ethics can, in fact, be formulated.