In August 2019, the Business Roundtable released a statement redefining the purpose of a corporation to maximize value “for the benefit of all stakeholders – customers, employees, suppliers, communities, and shareholders.” The statement was signed by 181 CEOs, including Jamie Dimon, chairman and CEO of JPMorgan Chase and chairman of the Business Roundtable, and came after several years of political pressure on behalf of stakeholder objectives, including by U.S. Senator Elizabeth Warren. In 2018, Warren introduced the Accountable Capitalism Act, which would require that directors of large corporations consider the interests of all stakeholders and that at least 40 percent of board members be elected by employees.
Proponents argue that stakeholder-focused objectives serve the greater good. Yet, critics continue to question the practicality and feasibility of these efforts. In a new study, we examine whether managers use recent social pressure on behalf of stakeholder interests as a means to reduce accountability for poor financial performance. To answer this question, we take advantage of the unique setting introduced by a quarterly earnings announcement. An earnings announcement has three characteristics that make it conducive for this type of examination. First, the market has a clear and measurable expectation of firm performance, measured by analyst earnings estimates. When the earnings report is released, performance is evaluated relative to this expectation. Second, managers typically speak to analysts and the media immediately following the earnings release to explain any over- or under-performance. Third, managers prioritize meeting quarterly earnings benchmarks, making their explanations of over- or under-performance relative to these benchmarks particularly informative.
Our study examines what factors lead managers to cite stakeholder objectives when explaining their firm’s performance. We analyze all manager communications during the two weeks following an earnings release, including on analyst calls, in news coverage, and during investor and analyst conferences. We look for managers that explicitly mention that their firm considers the interests of stakeholders as opposed to shareholders, citing terms such as “stakeholder value,” “the benefit of stakeholders,” or “stakeholder interests.”
Based on an analysis of public communications around earnings announcements, we find that managers are 34 to 43 percent more likely to cite stakeholder value maximization during periods following earnings announcements that fall short of market expectations. This finding is consistent with concerns that the inability to measure stakeholder value may reduce managers’ accountability for firm performance.
We employ several additional tests to ensure these findings are not driven by unobserved factors. We first use a discontinuity framework, examining earnings that are within one cent per share of analyst expectations. This test compares firms that meet or narrowly beat earnings expectations with firms that fall just short. The small variation in performance relative to expectations within this group reduces the likelihood of material differences between the underperformers and overperformers. In this setting, we continue to find that managers falling short of expectations are significantly more likely to cite stakeholder value following the earnings release.
We next test these tendencies in a difference-in-difference setting. The Business Roundtable statement increased public attention to stakeholder objectives and, with the endorsement of many well-known executives, made the pursuit of stakeholder objectives more acceptable to shareholders and society. Following this statement, firms became substantially more likely to cite stakeholder objectives. In our difference-in-difference setting comparing earnings releases shortly before the Roundtable statement with those coming shortly after, we find that the statement prompted managers to mention stakeholder value more frequently and that use of this narrative was most prevalent among firms that fell short of earnings expectations.
As social pressures have encouraged more firms to adopt a stakeholder focus, we next examine the characteristics of the timing in which a manager cites stakeholder value objectives. Focusing on each firm’s initial mention of stakeholder objectives, we again find these occurrences to be most likely to occur following poor performance. We then examine the choice to revert to not mentioning stakeholder objectives after explicitly mentioning them in prior quarters. We find that, after mentioning stakeholder objectives in a prior quarter, managers are more likely to not mention them in a quarter where the firm’s performance exceeds analyst expectations.
Managers seem to be aware that stakeholder-oriented goals may reduce their accountability for performance, but does the manager’s push for stakeholder objectives sway the board’s evaluation of an underperforming manager? We use CEO turnover-performance sensitivity, a measure used in numerous prior studies of CEO evaluation, to determine whether this behavior produces any observable benefit to the manager. Indeed, we find that it does; CEOs that cite stakeholder value maximization as an objective are less likely to see turnover following poor performance.
Throughout all of our tests, our findings are uniformly consistent with the concerns around stakeholder objectives; managers push to be evaluated by nebulous stakeholder-based standards when the more traditional (and easily measured) shareholder standards are unfavorable. Managers therefore become less accountable for firm performance as measured by traditional, market value-based metrics. In essence, the stakeholder focus becomes an excuse to explain away poor earnings performance while providing no way to measure whether stakeholders are actually receiving value.
One concern with these findings might be that stakeholder-focused firms inherently underperform on the shareholder-focused earnings-per-share metrics that we use to identify underperformance because of stakeholder-related expenses. Since we calculate performance relative to analysts’ expectations, such an argument would require the unlikely scenario in which analysts are unable to predict this underperformance. Nevertheless, we formally test this in a regression setting using Bloomberg Environmental, Social, and Governance (ESG) scores as a measure of a firm’s dedication to stakeholder objectives. If stakeholder-related expenses cause earnings to be lower, we would expect underperforming firms to have higher ESG scores. We find no support for this conjecture. Rather, we find firms falling short of analyst expectations on average have lower ESG scores, consistent with prior literature showing firms cut unnecessary costs in an attempt to surpass earnings thresholds.
Our analysis adds to the existing social discussion on stakeholder vs. shareholder maximization objectives and raises concerns about the proposed legislation on the issue. Absent a clear, defined approach for measuring stakeholder value, these proposals could actually lead to higher levels of managerial entrenchment, allowing underperforming managers to claim unverifiable successes.
This post comes to us from professors Ryan Flugum at the University of Northern Iowa and Matthew E. Souther at the University of South Carolina’s Darla Moore School of Business. It is based on their recent article, “Stakeholder Value: A Convenient Excuse for Underperforming Managers?” available here.