What Do Shareholders Want? Consumer Welfare and the Objective of the Firm

Ericson, Keith. 2024. “What Do Shareholders Want? Consumer Welfare and the Objective of the Firm.” NBER Working Paper 32064.

Abstract:

Shareholders want a firm’s objective function to place some weight on consumer welfare, motivated by both self-interested and altruistic motivations. Firms have a unique technology for improving consumer welfare: lowering inefficient price markups, which increases consumer welfare more than it lowers profits. Optimal pricing formulas can be adapted to account for shareholders’ marginal rate of substitution between profits and consumer welfare. Calibrations from preference parameters show many shareholders should place non-trivial weights on consumer welfare. A survey experiment on a representative sample elicits how shareholders would vote on resolutions giving strategic guidance to firms on what objective to pursue. Only 7% would vote for pure profit maximization. The median individual is indifferent between $0.44 in profits or $1 in consumer surplus, with those owning stocks preferring a lower weight on consumer welfare than non-stockholders.

General Interest Summary:

Shareholders want firms to set prices lower than the profit-maximizing price. Shareholders care about how firms treat consumers because they are consumers themselves. Shareholders also are people and people can be altruistic.

Firms have a unique technology for benefiting consumers: lowering prices that are marked up over cost. Economists know a lot about optimal price setting! Lowering prices doesn’t reduce profits much but has a big benefit for consumers– the firm gets less money per unit, but sells more. A simple calibration: a 10% reduction in prices in grocery stores gives a benefit to consumers approximately 20 times the cost in lost profits. (The exact amount varies depending on how competitive the market is.)

In my survey experiment examining how shareholders would vote, only 7% would vote for a firm they own shares in to profit maximize and put no weight on consumers. The median participant is indifferent between $44 more profits or $100 to consumers.

A common question is why don’t shareholders have firms maximize profits and just donate money to charity? Answer: firms have better technology for promoting consumer welfare—lowering prices gives much more benefit to consumers than firms lose in profits.

This paper is part of the literature that examines shareholder welfare maximization (see Hart & Zingales) instead of assuming shareholders only want to maximize monetary returns. Shareholders care about externalities and have social preferences, and that matters for how firms should act on their behalf.