Profit maximization: The ethical mandate of business
Profit maximization: The ethical mandate of business
Journal of Business Ethics; Dordrecht; Apr 1994; Primeaux, Patrick; Stieber,
John
Source (subtitle): JBE
Volume: 13
Issue: 4
Start Page: 287
ISSN: 01674544
Subject Terms: Profit maximization
Models
Ethics
Economic theory
Profit maximization
Models
Ethics
Economic theory
Profit
Economic theory
Business ethics
Classification Codes: 3100: Capital & debt management
2410: Social responsibility
1130: Economic theory
Abstract:
A model is proposed for business ethics which arises directly from the business
practice. This model is based on a behavioral definition of the economic theory
of profit maximization and situates business ethics within opportunity costs.
Within that context, it is argued that good business and good ethics are
synonymous, that ethics is at the heart and center of business, and that profits
and ethics are intrinsically related.
Full Text:
Copyright Kluwer Academic Publishers Group Apr 1994
In the contemporary world of commerce, the very term "business ethics" creates a
kneejerk reaction in executive suites signaling negative, defensive responses.
Why? Partly because "business ethics" has become associated with abuse and
mismanagement. Partly because "business ethics" is a relatively new term, a
misunderstood concept, which frightens managers.
There also exists a tendency by detractors of the present economic system to
universalize exceptions and to think that all men and women in business are
seeking greed and power for its own sake. Basic to our argument is a sense of
faith and trust in humanity, that the vast majority of men and women in business
are struggling to do the right thing in the pursuit of good ethics. Also basic
to our argument is a faith and trust in private enterprise and its inherent
tendency towards equilibrium and balance. A few exceptions, a few mistakes do
not reflect the good ethics of the majority. That same positive, optimistic view
of humanity and of the open market is not shared by the traditional voices of
morality and ethics - philosophy, religion, and law--at least not to the
practical degree of the business enterprise.
Consider the virtually impossible task of a Defense Department contractor trying
to keep informed and updated on rapidly changing government specifications and
regulations. The minute a failure is detected, a red flag is thrown into the air
and charges of unethical cheating and over-charging the public become headlines
in our newspapers. Once the charge is made the damage is done. Human and
financial resources are immediately directed coward clearing the charges through
a bewildering maze of litigation. Cleared of deliberate or intentional
wrong-doing, it is often said that the contractor is lucky to read a fifth-page,
small-print announcement.
In this hypothetical case, as in so many others, there exists an implicit
mythology on the part of the media (and on the part of the public) which assumed
that business is inherently unethical. The business enterprise is besieged by
popular misconceptions as well as by legal, religious and academic theorists
anxious to prove that business seeks only self-serving aggrandizement, i.e., to
maximize its profits and to do so at any cost to the consumer, the community and
the environment. Constantly besieged by these kind of assertions, it is little
wonder that business is defensive in matters concerning ethics.
There are two ways in which business theory and practice can respond to negative
ethical allegations. First, there is a need for business to clarify its function
within society as a whole, i.e., to define its role along side those other
social entities concerned with ethics in general and business ethics in
particular such as academic philosophy, religion and law. Second, there is a
need for business to situate ethics within the heart and center of its very
self-identification, i.e., within private enterprise and profit maximization.
1. BUSINESS WITHIN SOCIETY
What is the role of business within society as a whole? In an earlier essay,
John Stieber addressed that question and answered it directly and simply: "to
provide the goods and services the consumer wants ..."(1) The word "wants" is
deliberately used to distance business from the judgmental implications of
personal or communal "needs." The implication here is that judgment or choice
belongs to the individual consumer.
This question of judgment demands explanation. Decidedly, the "open market" or
"private enterprise" system rests in individual decision-making. The "judge"
within this economic frame of reference is any individual who possesses the
freedom to produce or not produce, to purchase or not purchase any product he or
she so desires. According to the private enterprise purist, the market will
regulate itself without any need for externally induced controls. Likewise, in
questions of judgment, ethical decisions about the purchase or sale of a product
will be determined and/or regulated by the market in compliance with the free
choice of individuals. Ideally, there would be no need for external ethical
controls.
Who determines whether there exists a "want" for guns? The individual consumer
does. Were the individual consumer to judge that he or she had no "want" for
this particular product, it would not be produced. On the other hand, if the
producer judged, in conscience, that he or she should not produce this item, it
would not be produced, at least not by that individual. It could, however, be
produced by another individual whose ethics would allow him or her to do so.
There is, then, integral to the private enterprise economic system a bias
towards individual ethics and judgments. This bias is grounded in a positive
evaluation of individual human dignity and the capacity of the human spirit to
choose what is best for itself. That decision or judgment is, accordingly, made
by the individual who may or may not, to one degree or another, be influenced or
not influenced by implicit or explicit philosophical, religious or legal tenets.
Even though free market theory and business practice focus on the individual as
the locus of judgment or choice, that individual judgment or choice is
influenced or tempered by social, communal factors, i.e., by the judgments and
choices of others. It is precisely through genetic and environmental development
factors (influenced by philosophical, religious, and legal concerns) that this
social dimension is realized. These factors and influences situate the
individual within society and provide a context for individual decision-making.
Business and free enterprise have always valued that social dimension and have
always realized its practical significance. In practice, both the producer and
the consumer have also been conscious and aware of social customs, values and
beliefs when buying and selling. Stieber recommends an economics based not
simply on "providing goods and services the consumer wants," but doing so within
the "ethical mores of society."(2) If the individuals who comprise a particular
society perceive birth control methods to be unethical, those particular items
would not be bought. Nor would any producer, sensitive to the ethical mores of
that particular society, attempt to produce or market them. Or, perhaps he or
she would attempt production and distribution, thereby moving to change ethical
mores. That change could not or would not occur unless a significant number of
individuals would themselves choose to do so. Is that not one way in which
change is realized?
We can, of course, continue to discuss the relationship between the individual
and the community in an abstract manner, questioning to what degree any
particular relationship is more or less individualist or communal. We can also
question to what degree the individual or the community has precedence in moral,
ethical judgment. However, inquiries of that kind fall within the realm of
philosophy which is at least two, if not three, steps removed from practical
decision-making in business.
2. PROFIT MAXIMIZATION AND BUSINESS ETHICS
Perhaps an analogy may help to substantiate the argument. The individual athlete
approaches a game of football with his or her own personal sensibility to a
certain philosophical perspective, religious commitment, and adherence to the
law. That sensibility may even define the individual athlete and his or her
relationships with others. In practice, however, that sensibility is "bracketed"
or suspended as the rules of the game assume precedence. Of course, the
individual can make a prior choice to play or not to play, and perhaps
philosophical, religious or legal commitments may inspire that choice. But once
that choice has been made the rules of football dictate a certain behavior.
We would argue, as in the case of a game of football, that there are rules of
business which, in practice, take precedence. We would also argue that the rules
of business actually constitute the basis for a business ethics which is both
internally consistent and externally valid.
Essentially, we would define business ethics in terms of neo-classical economic
theory and its advocacy of profit maximization. Integral to our understanding of
profit maximization is a behavioral dimension which reaches beyond an exclusive
preoccupation with bottom-line profit and, at the same time, presumes a social
or communal dimension as integral to business. In other words, we would not
define business exclusively in terms of individualist self-aggrandizement or
self-interest but, rather, in terms of a behavioral efficiency of benefit to
both individuals and society that is embodied, but usually overlooked, in the
behavior of profit maximization.
The neo-classical theory of economic efficiency is rooted in a dual realization:
(1) that men and women in business are managers and (2) that managers allocate
scarce resources of land, labor-time, capital, and human creativity in a world
of unlimited human wants. The success or failure of a manager is measured by the
amount of goods or services produced from a given sec of scarce resources. Those
who produce the most are efficient; those who produce less are inefficient. The
human behavior driving this efficiency is prescribed in the paradigm of profit
maximization.
When business men and women profit maximize, i.e., allocate resources
efficiently, people have more of the things they want, and that is good. When
they do not profit maximize, i.e., allocate scarce resources inefficiently,
people have less of the things they want, and that is bad. This is especially
true if the things they want are food, health care, education, and other
necessities of life. Since ethics is basically a study of good and bad activity,
then the decision to profit maximize or not to profit maximize becomes a
question of applied or practical ethics.
Unfortunately, the ethical considerations prescribed in the profit-maximization
paradigm are much more complex than one might readily perceive. The simple
choice to profit maximize or not to profit maximize is deeply rooted in
behavioral tenets which tie the allocation of scarce resources to good business
as well as to good business ethics.
The origins of profit maximization, with its own ethical considerations and its
own tenets, originated in antiquity. When Adam and Eve were evicted from the
Garden of Eden they discovered how once upon a time, in illo tempore, inside the
garden they had unlimited resources. They could have anything they wanted.
Evicted from the garden, they discovered that resources were scarce and that
survival and prosperity demanded efficient management of these scarce resources.
Because they did survive, it is safe to presume that they had learned the basic
tenets of profit maximization.
There are two ways to examine the tenets of profit maximization. One is from a
technical perspective; the other from a behavioral perspective.
Technically, profit maximization is defined as that set of conditions where the
marginal revenue of the firm is equal to its marginal cost (MR = MC)(3) and the
marginal cost curve must intersect the marginal revenue curve from below. For
the manager of the firm, these conditions mean that the firm will continue to
produce as long as the revenues from each unit sold exceed the cost. As more
units are produced, the scarce resources used reach diminishing returns hereby
causing marginal cost to increase. Eventually, marginal cost will equal marginal
revenue. At that point, and only at that point, the firm will be operating at a
level of output that guarantees the community the maximum amount of goods and
services the firm can produce with the given set of resources it has.
If the firm produces at a point where marginal revenue is greater than marginal
cost (MR > MC), it is choosing a level of output that is less than the profit
maximizing output, and the community will have fewer goods and services.
Inasmuch as more homes, more education, more health care, etc. from a given set
of resources are good, and less of these goods and services from a given set of
resources are bad, there is an ethical dimension associated with any decision to
produce at an output level where marginal revenue is greater than marginal cost
(MR > MC).
If the firm produces at a point where marginal revenue is less than marginal
cost (MR < MC), it is choosing a level of output that is greater than the
profit-maximizing output, and the community has more goods and services. The
problem with this decision is that it costs more to make these additional units
of output than the revenues they generate, and the company will lose money. It
is axiomatic that any firm continuing to produce at a loss will eventually go
out of business. Therefore, what first appears to be a windfall for the
community turns into a disaster. The firm shuts down, all of the things it once
produced, including the windfall, disappear; and the community has fewer goods
and services. As before, there is an ethical dimension associated with the
decision to produce where marginal revenue is less than marginal cost (MR < MC).
Everyone would be hurt: managers, employees, stockholders, consumers and the
community as a whole, i.e., less taxes, employment and philanthropy.
Since more is better than less from a given set of scarce resources, producing
where marginal revenue is equal to marginal cost (MR = MC), profit maximizing,
is efficient and ethical. Producing where marginal revenue is greater than or
less than marginal cost, not profit maximizing, is inefficient and unethical.
That ethical judgment rests first and foremost within practical economics and
has consequences for individuals as well as for society as a whole.
Today there is a tendency to think of profit maximization from a purely
technical perspective. Milton Friedman's well-known statement that "the social
responsibility of business is to increase profits"(4) belongs to this technical
perspective and probably would never have occurred to Adam and Eve. For them,
the social responsibility of managers would go beyond bottom-line profits. They
would have been concerned, however, with Friedman's understanding that the
responsibility of the corporate executive "is to conduct the business in
accordance with [the owner's] desires which will be to make as much money as
possible."(5) They would not have understood that imperative to refer
exclusively to bottom-line profits or individual aggrandizement without
considerations of its effect on others.
Nor would they have agreed with Friedman's injunction that the corporate
executive "makes as much money as possible while conforming to the basic rules
of society, both those embodied in law and those embodied in ethical custom."(6)
They would have thought Friedman was confusing the issue. Rather than
identifying business as integral to society, Friedman sets business apart to be
judged or regulated by society's standards: philosophical, religious, and legal.
Adam and Eve would have perceived profit maximization at the very heart and
center of society, and its values consistent with those of society.
From a behavioral perspective, profit maximization is defined as the act of
producing the right kind and the right amount of goods and services the consumer
wants at the lowest possible cost (within the legal and ethical mores of the
community).(7) The phrase "within the legal and ethical mores of the community"
is placed in parentheses because, as we shall soon see, they are already
contained within the costs of the firm Businesses know they are producing the
right kind of goods and services if there is a market demand for them, i.e., if
consumers are willing to pay a price for them. The use of the word "right" in
this phrase implies ethical considerations, which, as we mentioned earlier, are
rooted in the individual conscience of the producer and consumer.
In North America, where consumers are becoming more aware of the medical
difficulties associated with smoking, cigarette sales have declined. In other
areas, where information is not as readily available or where different cultural
factors take precedence over the medical, cigarettes are in greater demand. Is
it the role of business to decide that cigarettes should not be supplied to
them? According to the rules of private enterprise, that decision should be made
by the (even unenlightened) consumer and producer who is willing to supply the
product.
Businesses also know when they are producing the right amount of good and
services. It is, as we have just demonstrated, that level of output where
marginal revenue is equal to marginal cost (MR = MC). Any other output level
would be inefficient and, consequently, unethical.
Producing at the lowest cost is probably the most recognizable tenet of business
behavior. Failure to be cost-reduction sensitive could jeopardize the ability of
the firm to survive. Other firms in the industry are keenly aware that lower
costs give them an advantage in the marketplace. Low-cost advantage, maintains
the highly acclaimed British economist Alfred Marshall in his Principles of
Economics, "permeates all the economic adjustments of the modern world."(8)
The costs of production for any firm can be, and usually are, systematized into
three general categories: fixed, variable, and opportunity costs. Fixed costs
can be defined as those costs which do not vary with output, such as plant and
equipment costs. Variable costs can be defined as those costs which do vary with
output, such as labor-time and materials. Opportunity costs can be defined as
the foregone goods and services that could have been produced from a given set
of resources that were used to produce some other goods and services.
Because managers are constrained by statute to certify only the fixed and
variable costs of the firm, he opportunity costs incurred by the firm seldom
appear in its financial statements. When they do, one must look for them in
footnotes.
On the other hand, managers are not subject to the constraints of statutes when
they examine the opportunity costs of their decisions. Many of them are aware
(and if not, should be aware) that opportunity costs can be significant for any
decision. They are also aware that philosophical, religious, and legal
considerations represent some, but not all, of the opportunity costs to which
they must be sensitive.
There are two key phases in our definition of opportunity costs that should help
us understand their role in business decisions and how ethical considerations,
or lack thereof, bring about opportunity costs for the firm. The two phases are
"the foregone goods and services" and "from a given set of resources."
Assume that a business has a fixed amount of money from the earnings it has
retained to invest for its owners. Further, suppose it decides to start a used
car lot in an Amish town. Once these resources ("a given set of resources") are
committed to the project, they can never be used to produce any other goods and
services for the community such as health care, education or housing ("foregone
goods and services").
Besides the usual business considerations associated with this decision
(location, lease costs, hiring, taxes, etc.), there is a serious ethical
consideration that must be addressed. The Amish do not drive cars. Were
management insensitive to this ethical behavior, the project would fail and the
resources would be lost.
If the project were to fail because the management of this firm was insensitive
to the ethics of the situation, the opportunity costs for the community would be
that a whole set of scarce resources was used to produce something consumers did
not want. Furthermore, these wasted resources can never be used to produce
anything else. The opportunity cost for the firm is a loss of money from a set
of scarce resources that could have been used for another project.
From a broader perspective, what we see in this example is that managers who do
not examine the ethical dimensions of their decisions create negative economic
consequences which represent opportunity costs for their companies and
consumers. These managers would not be profit maximizing because they failed to
consider the opportunity costs associated with the ethical dimensions embodied
in any and every decision-making situation.
Usually the ethical considerations associated with a business decision are more
complex than trying to sell used cars in an Amish town. In November of 1976, a
customer of General Motors took his 1977 Oldsmobile Delta 88 to a mechanic for
servicing.(9) The mechanic discovered a Chevrolet engine under the hood.
Reporters for the mass media became interested in the story, and a flood of
adverse publicity led to a storm of public indignation and class action against
GM. There were charges of fraud and unethical behavior.
In its defense, General Motors claimed it did no wrong, that interchanging parts
was a common practice in the industry. The automobile manufacturer tried to
explain the practice and demonstrated that its behavior was in the best interest
of the consumer because it reduced costs. Five months later, in an attempt to
stop public controversy and reduce its legal liability, GM offered a settlement
to the affected car buyers.
It has been estimated that the settlement was forty million dollars. There were
also extensive legal costs which have never been revealed. These were dollars
that could never be used again to develop or produce other goods and services.
There were, to be sure, other opportunity costs. Incalculable human resource
hours and energy were lost. Rather than directing these hours and energies to
enhance the interests of stockholders, employees, and customers, they were used
to put out fires. In addition, no one knows how many customers were driven off
or what it might cost to bring them back.
The important question here is whether management followed the prescribed
behavior required by profit maximization and examined the ethical considerations
of this decision. If not, they were not profit maximizing and, a priori, were
not ethical.
Be that as it may, what if management did follow the prescribed behavior of
profit maximization and concluded that its choice to interchange automobile
parts was consistent with the ethical mores of the community? Even though its
judgment proved to be wrong, GM management had at least cried to evaluate the
ethical dimensions of its decision. We would argue that the very behavior of
considering the ethical mores of the community would, of itself, meet the
minimum requirements of profit maximization In effect, the decision required an
evaluation of GM's opportunity costs and a projection that the opportunity costs
of interchanging automobile parts would equal zero.
The difference between examining the ethical considerations of a decision and
not examining them is absolutely crucial. No one expects managers to be
omnipotent. We can, however, expect managers to consider ethical mores as they
would any other opportunity cost when making decisions. If they do that, they
are profit maximizing. Sometimes we forget that the nature of decision-making is
such that managers, in good faith, can examine all of the available data and
still make wrong decisions. Good ethics does not guarantee perfection, and good
business ethics does not guarantee perfect decisions.
However, by examining the opportunity costs of ethical considerations, managers
are realizing that there are behavioral options which surpass individual
self-aggrandizement or bottom-line profits. That is, they are realizing the
existence and significance of the social dimension within the business
enterprise that goes beyond a regulatory agency standing outside of and apart
from business. They are also realizing that within the practical, behavioral
dimension of profit maximization there exists an objectivity that can and does
play a pivotal role in business ethics. The objectivity of profit maximizing,
while recognizing individual differences, surpasses and grounds these
differences.
3. INDIVIDUAL ETHICS AND PROFIT MAXIMIZATION
As the rules of a football game assume precedence over individual ethical
sensibilities, so do the rules of profit maximizing in business assume
precedence over individual ethical differences. In business, as in football,
individual values and beliefs become suspended or bracketed, especially those
that are at odds with the game. Furthermore, even though philosophical,
religious and legal considerations may influence one's choice to play the game,
once the decision is made to enter the playing field, the rules of the game take
precedence.
On a more practical note, how does one respond to a situation where there is a
conflict between the personal ethics of the manager and the ethical
considerations of a business decision? Suppose the senior management
representative on a committee of managers considering a potential business
decision must approve or disapprove the recommendation of the group. All of the
fixed and variable costs have been calculated, the opportunity costs (including
the ethical considerations) have been examined, and the consensus of the group
is to proceed. However, the senior manager cannot reconcile his or her own
personal ethics with the consensus of the group. What does the profit
maximization model require?
Profit maximization does not include personal ethics; only the opportunity costs
of not being sensitive to the ethics of the community. However, it does include
the inefficiencies that can be created by the manager if this conflict leads to
paralysis of ineffectiveness. The manager has no recourse but to resign.
When, in 1978, Holiday Inn decided to open up a hotel and casino in Las Vegas,
Nevada, the president of the company faced a dilemma. His personal ethics were
at odds with that of the community's acceptance of gambling. He knew the
decision was in the best interest of the company, but he could not reconcile it
with his own aversion to gambling, so he resigned.
To have given up all of the economic advantages and prestige of being president
of a major corporation indicate the depth of commitment this man had to his
personal ethics as well as to the profit maximization objectives of the company.
To his unending credit, his behavior was consistent with profit
maximization.(10)
If, on the other hand, managers are able to reconcile conflicts between their
personal ethics and those involved in any profit maximization decision, there is
no problem. They will continue to be effective, and their behavior will be
consistent with the demands of profit maximization. However, any time this
happens, the manager has essentially changed his or her ethics because, a
priori, one cannot enter into a process of reconciliation without changing one's
values. From an economic perspective, it could be argued that the individual
manager sold all or part of his or her ethics for another set of ethics.
One of the major postulates of economics is that personal attributes and talents
such as self-respect, decency and ethics are also economic goods as are food,
shelter and health care. Like all economic goods, they also are bought and sold.
Usually, the practice of buying and selling involves an explicit price.
Sometimes, though, economic goods are bought and sold for other economic goods,
i.e., bartering.
Like other people, managers barter with their ethics. They trade, as everyone
does, their childhood ethics for adult ethics. If they didn't, they wouldn't
mature. They also sell their ethics for a money price, even putting
aside/reconciling their personal ethics for a good-paying job.
Whether the behavior of buying and selling one's personal ethics is right or
wrong is the realm of the philosophical or religious moralist. We know that
people do it and that the discipline of economics describes how they do it.
However, we also know that the paradigm of profit maximization refers to
personal ethics only to the extent that any conflict between the ethics of the
manager and that of the company which leads to personal inefficiency requires
that he or she resign.
What we have tried to demonstrate in this essay is that the behavior of profit
maximization includes an examination of the opportunity costs associated with
all business decisions and that ethical considerations represent some, but not
all, of the opportunity costs of a given decision. We have also argued that our
behavioral paradigm of profit maximization provides an objective basis for
business ethics, i.e., a basis for business ethics which is inherent to business
itself.
Contrary to popular misconceptions, profit maximization doesn't encourage
flagrant disregard for community standards of pollution, safety, exploitation of
human and natural resources, etc. Profit maximization demands that the ethos and
mores of the community become integral to the decision-making process. In fact,
issues raised by philosophical, religious and legal concerns are also the
concerns of business and its required sensitivity to the community embodied in
opportunity costs.
As we mentioned earlier, managers do make mistakes in their evaluation of
ethical issues that relate to business, but so do lawyers, college professors,
physicians and ministers with regard to their own professional ethics. We all
know that there are business men and women who abuse the ethics of business, but
so do other professional men and women. That doesn't mean that profit
maximization is bad. It means that people who deliberately violate the precepts
of this economic behavior are bad.
As it relates to personal ethics, profit maximization is clear. It does not
include them in the model. However, it does recognize the inefficiencies that
can be generated in the event of a conflict between the personal ethics of the
manager and the ethics of the company.
NOTES
1 Stieber, J.: 1987, 'The Role of Profit in our Social Organization', Handbook
of Business Strategy, 1986-87 Yearbook (Warren, Gorham, and Lamont, Boston), Ch.
8.
2 John Stieber, Ch. 8.
3 Profit (pi) = Total Revenue (TR) - Total Cost (TC) pi = TR - TC = f(x) = g(x).
The first-order conditions for profit maximization are:
d(pi)/dx = f'(x) - g'(x) = 0
or
f'(x) = g'(x)
That is,
MR = MC
The second-order conditions must show:
d(d)(pi)/d(x)(x) < 0.
4 Friedman, M.: 1988, 'The Social Responsibility of Business is to Increase Its
Profits: in T. Donaldson and P. H. Werhane (eds.), Ethical Issues in Business: A
Philosophical Approach (Prentice Hall, Englewood-Cliffs, NJ), p. 218.
5 Milton Friedman, p. 218.
6 Milton Friedman, p. 218.
7 John Stieber, p. 8.
8 Marshall, : 1962, Principles of Economics (Macmillian & Co., London), p. 335.
9 Steiner, G.A. and J.F. Steiner: 1980, Casebook for Business, Government, and
Society (Random House, New York), pp. 124-126.
10 Letter from Kemmons Wilson to John Stieber, August 13, 1990, private papers
of John Stieber.
Department of Theology and Religious Studies, St. John's University, Jamaica,
New York, U.S.A.
Department of Finance, Edwin L. Cox School of Business, Southern Methodist
University, Dallas, TX 75275-0033, U.S.A.
Marist Father Pat Primeaux is a Professor of Theology at Saint John's
University, (New York). John Stieber is a Professor of Finance and Economics at
Southern Methodist University's Edwin L. Cox School of Business (Dallas). They
have collaborated on several articles on the behavioral dimension of economic
efficiency. They have also designed and taught courses in business ethics at
both the graduate and undergraduate level.
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