Is Stakeholderism Bad for Stakeholders?

A series of recent papers (here, here, and here, for example) have argued that maximizing shareholder value remains the proper goal of the modern corporation – and in some cases that stakeholderism is in fact harmful to stakeholders. Yet giving up on stakeholderism for the sake of stakeholders cannot be the right answer or strategy, even though there are significant challenges to steering away from the currently prevailing framework.

Although the papers differ in the details of their arguments, they share some common themes:

  • Corporate managers do not and will not use discretion to benefit non-shareholder constituents; delegating the protection of stakeholder interests to them is therefore futile. Worse still, providing managers with more such discretion may give them cover to act in a manner that benefits themselves, thereby reducing firm value and harming shareholders, stakeholders, and society.
  • Managers have a serving-two-masters problem: Under stakeholderism, they would have to reconcile various conflicting interests, which is impossible to do; shareholder value maximization is therefore the only viable corporate purpose.
  • Stakeholderism, if adopted, would raise illusory hopes and weaken pressures for policy reforms beneficial for stakeholders. Stakeholderism is therefore counterproductive.
  • The issue of stakeholderism should be addressed by external regulation, including labor, antitrust, consumer protection, and environmental laws.
  • Providing new, more stakeholder-oriented incentives to managers – such as via redesigned compensation packages and modifications to the system of director elections – would be challenging and costly.

Even though various parts of these statements are certainly true, these objections do not necessarily support the conclusion that stakeholderism is harmful for stakeholders. Rather, the statements only represent hurdles to arriving at a corporate pluralist purpose; hurdles that can, and should, be overcome with sufficient societal and political support. Indeed, one could rethink or counter the statements to arrive in favor of a more pluralist corporate purpose.

The following represents a first attempt at such a rethinking, based on some of my previous work on corporate purpose and corporate duties to the public.

  1. Managers do not use discretion to benefit stakeholders, and may even abuse discretion: Most businesses have not shown much genuine interest in advancing non-shareholder interests, and approaches that ask boards to “consider” stakeholder interests have shown little to no impact. But instead of giving up on stakeholderism, the response should be to curtail managerial discretion. For example, the law could expressly put shareholder and stakeholder interests on an equal footing. This could be complemented with a requirement for corporations to balance the positive and negative impacts of their actions, affecting shareholders and stakeholders, against each other. One subvariant of this approach would be to specifically require boards to strive to pursue net beneficial (for the public as a whole) corporate activities, taking into account financial and non-financial interests of any stakeholder group, including shareholders. Although such calculations are difficult to make and not an exact science, legislative guidance along the lines of these considerations could lead to improved outcomes by forcing corporations to consider the overall effects of their decisions and activities as precisely as possible. Another, more radical option would be to allow boards to pursue harmful actions for certain non-shareholders only if the costs of doing so could be justified in the provision of sufficient benefits to other non-shareholders. This would effectively be an attempt for corporations to counterbalance negative externalities at their roots.
  2. Managers cannot consider multiple interests at once: Concerns that the pursuit of multiple goals – beyond a sole focus on profits – would have negative effects on managerial performance and behavior appear increasingly unfounded. Good managers, supported by technology, can handle complexity. Modern corporations should be capable of pursuing a variety of goals at once, optimizing their performance along several benchmarks. Additionally, it may be overly simplistic to assume that shareholder wealth maximization is a singular, easily delineated goal. Shareholders are diverse, too, with varying investment timeframes and levels of risk tolerance.
  3. Stakeholderism concerns should be addressed via external regulation, and adopting a broader corporate purpose would simply weaken the impetus for regulatory action: Without a doubt, external laws and regulations are necessary and important tools to protect stakeholders and societal interests. Corporate actions are no substitute for governmental action, and it is primarily the role of legislatures and policy-makers to ensure adequate protections of public health, the environment, employees, etc. However, these external protections should be complemented with actions and behavior on the corporate level. External regulations and stakeholderism are not exclusive alternatives; they should work in tandem. It is plausible that increased corporate commitment to stakeholderism would give politicians cover for reducing their own initiatives in this regard. But to argue that, because of this possible effect, business should continue in its old ways seems unjustified. Based on the growing impact that corporations have on society at large, and given that liability and enforcement after the fact are better complemented by ex-ante duties, the consideration of broader stakeholder interests should be a fundamental part of the corporate mission.
  4. Redesigning managerial incentives is difficult and costly: While this is certainly true, it is also a cost-benefit issue, and not in itself a reason for rejecting stakeholderism. The prospective costs of the ongoing health crisis and the likely much larger impacts of the looming climate crisis – both of which have corporate governance implications – should serve as a reminder of the potential impacts of failing to adequately safeguard societal concerns and may well justify even the most difficult reform measures. Furthermore, with more mandatory changes to the corporate purpose, as proposed above, incentives that aim to elicit voluntary action would become far less important. In short, today’s costly and difficult measures might well look prudent and necessary in hindsight. Let us not wait for a Minsky moment before taking up reform measures.

Instead of continuing with business as usual, corporate law needs to be recalibrated, with the core of this change lying in provisions on the corporate purpose, related director and management duties, the business judgment rule, and enforcement or review mechanisms. These reform measures do not replace external, non-corporate regulation, but rather act as a necessary corollary and ex-ante strategy. Stakeholderism certainly poses many significant challenges, but it is only bad for stakeholders if it is not properly implemented.

This post comes to us from Professor Martin Petrin at University College London and Western University. It is based in part on his recent book, Corporate Duties to the Public.

1 Comment

  1. Henry D. Wolfe

    In a stakeholder model, how does a board make a decision in the following situations:

    • A combination of minimum wage increases and declining costs of technology resulted in a company’s ROC hurdle rates being cleared for the installation of robots on the production lines of several manufacturing plants. As a result, a number of employees would lose their jobs. There is nowhere else within the company to relocate these employees. With a “stakeholder” model, is the decision made to install the robots (shareholders) or to not install the robots (employees)? For which “stakeholder” does the board decide?

    • A company develops a product that is a key input for another company’s product. This product is of equal quality to that of the incumbent supplier but at a lower price. The incumbent supplier refuses to lower its price. In a “stakeholder” model, is the decision made to engage the new supplier with the lower cost product (shareholders) or to keep the incumbent supplier, who has been a “stakeholder” for 20 years, with the higher cost product in place (suppliers)?

    • The new owners of a company implement a detailed analysis of the profitability of each of the company’s customers. This analysis shows that 5% of the customers are unprofitable with no means to shift them to a profitable level. In a “stakeholder” model is the decision made to drop these customers (shareholders) or to retain them (customers)?

    • And finally, one additional employee example that has an extended message: An analysis is done of a significantly underperforming company where I had just become non-executive chairman. One of the results of this analysis is that virtually every department of the company is bloated and overstaffed. (It is one of those situations where you walk through a company’s headquarters and even prior to the analysis, you wonder, “what in the hell do all of these people do?”) And, the analysis also demonstrates that the salesforce is not only overstaffed but roughly one third are very poor performers and have been for many years. With a “stakeholder” model, what do you do? Do you downsize the company (shareholders) or do you maintain the status quo (employees)? As there was not a “stakeholder” model operative here, the decision was made to make considerable headcount reductions at this bloated company. This included terminating the underperforming bottom third of the salesforce and parceling out their territories to the remaining sales people who went on perform at a very high level. And, there were numerous other changes made at this company that over time resulted in it moving from the worst performer in its industry to actually setting new best-in-class standards for key metrics. The culture of the company was shifted from one that was “paternal” in nature to one that required high levels of accountability. To advocates of the “stakeholder” model, this may seem evil and much too focused on making money. But consider this: Several years into the process of taking this company to new levels, I received a letter from one of the company’s vice presidents. She was writing to me as chairman with a message for the entire board from all the middle management and employees. The intent of the letter was to thank the board for taking action to improve the company and for hiring the new CEO a few years earlier. In reference to the CEO, she stated that he was the toughest SOB for whom any of the employees had ever worked. But, she went on to say, he led them to accomplish things that none them knew were even possible. And, the upshot was, she said, that the entire workforce was happier than at any time since they had worked for the company. What? We implemented an evil Shareholder Value Maximization model and the employees were happier than ever? Were they delusional? Had they perhaps developed “Stockholm Syndrome?” Of course not. Those that had been long-term employees who remained were the ones who had always been highly personally responsible individuals. Many had been stifled by the former model which in effect was a form of “stakeholder” model and resented the fact that everyone in the company was treated as equal regardless of their performance. With the shift to a focus on developing the full potential of the company, all of that changed. Now, performance was expected and rewarded; the higher the performance, the higher the reward. There was excitement within the company as the longer term targets were clear and demanded a huge effort to reach. In actuality, this model, which was heavily focused on maximizing shareholder value, was better for the employees than the “stakeholder” model had been. (But better only for those who were willing to stretch and be totally accountable).

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