In a new paper, I offer three interpretations of stakeholder theory—one economic, one philosophical, and one political.
Shareholder Theory vs. Stakeholder Theory
Traditional principles of corporate law require directors to manage the corporation for the benefit of its shareholders. Stakeholder theory, however, requires directors to manage the corporation for the benefit of everyone affected by its operations. Historically, this encompassed shareholders, employees, customers, creditors, suppliers, and the communities in which the corporation operates. In an age of climate change, however, some theorists expand the class of stakeholders to include all human beings now living or to be born in the future.
Although more than half of the states have adopted some form of stakeholder theory by statute, Delaware’s steadfast adherence to traditional shareholder theory, coupled with its continuing dominance in the market for incorporations, has made the practical impact of stakeholder theory negligible.
Stakeholder theory enjoys perennial support in academia, but many scholars have argued that the theory is hopelessly indeterminate. It requires directors to choose the action that is best for all stakeholders collectively, but it provides no criteria by which any action can be recognized as being any better or any worse than any other. Virtually every possible corporate action will benefit some stakeholders and harm others (e.g., paying employees higher wages will result in higher prices for customers), and the theory has literally nothing to say about how the interests of some stakeholders should be traded off against the interests of others. Indeed, even an action that benefited literally every stakeholder may be wrong under stakeholder theory if it increases inequality among stakeholders by benefiting wealthier stakeholders more than poorer ones.
To avoid this radical indeterminacy, stakeholder theory must be supplemented with additional substantive normative premises, and I argue that there are three obvious sources from which such premises may be drawn: welfare economics, moral philosophy, and political theory.
The Welfare Economic Interpretation of Stakeholder Theory
Welfare economics is based on the assumption that what is best for a group of individuals is a function of the preferences of those individuals—in contradistinction, for example, to what someone else may think is best for those individuals in some normative sense. Welfare economics thus begins with a group of individuals (in stakeholder theory, these would be the corporation’s stakeholders, however this class may be defined) and some information about the preferences of these individuals regarding a set of alternatives (in stakeholder theory, the various actions the corporation might take).
We next assume that we know each individual’s ordinal preferences, meaning that, for each individual and each pair of alternatives, we know whether the individual prefers the first to the second, the second to the first, or is indifferent as between the two. Using an individual’s ordinal preferences, we can construct an order of the alternatives, ranking them from the individual’s least preferred to his most preferred, allowing for ties when the individual is indifferent as between two alternatives. A set of such orders, one for each individual, is called a profile.
We then want to construct a social welfare function, a function that maps each profile to an order of the alternatives that we interpret as aggregating the individual preferences in the profile into a social ordering of the alternatives from the least preferred to the most preferred across society. Shockingly, however, under Arrow’s Impossibility Theorem, given some very mild constraints, aggregating ordinal preferences in this way is mathematically impossible.
As a result, welfare economists generally turn to Amartya Sen’s framework based on cardinal preferences. Cardinal preferences tell us not only whether an individual prefers one alternative to another but also how much an individual prefers one alternative to another (the measurability of utility) and how one individual’s preferences compare with those of other individuals (interpersonal comparability of utility). With cardinal preferences, we can say that individual i’s utility would increase by the same amount in a change from alternative x to alternative y as individual j’s would in a change from alternative u to alternative v.
But now there are too many possible social welfare functions. The Benthamite function computes social welfare by summing individual utilities, the Bernoulli-Nash function by multiplying them, and the Rawlsian function by equating social welfare to the utility of the worst-off member of society. Indeed, there are infinitely many possible social welfare functions and no canonical way to choose among them. Worse, each choice reflects certain value judgments. For example, the Bernoulli-Nash function produces more egalitarian outcomes than the Benthamite function, and the Rawlsian function produces even more egalitarian outcomes than the Bernoulli-Nash function. This is a serious problem because much of the attraction of assuming that social welfare was a function of the preferences of individuals lay in the hope of avoiding making such value judgments.
Worse still, most economists doubt that the measurability and interpersonal comparability implied by cardinal preferences reflect any genuine facts in the world, let alone any that we could know empirically. These doubts, along with the inevitability of making value judgments in order to select a social welfare function, lead many welfare economists to conclude that cardinal preferences should be reinterpreted not as facts about individuals but as value judgments of a social planner trying to maximize social welfare. On this view, to say that Jones gets 10 times the utility from a hot meal than Smith gets from a game of golf is really to say that we ought to trade off hot meals for Jones against golf games for Smith at the rate of 10 to one. Once we make this move, however, we are into the realm of moral philosophy.
The Moral Philosophic Interpretation
The moral philosophic interpretation of stakeholder theory supplements the theory with robust normative premises from some form of moral philosophy, albeit any of various. Kantian deontology, Aristotelian eudaimonism, Thomistic natural law, radical feminism—any form of moral philosophy will work. Indeed, if we assume that directors have a moral obligation to run the corporation for the benefit of its shareholders, then even traditional shareholder theory becomes a form of stakeholder theory. Perhaps surprisingly, leading stakeholder theorists expressly concede all this, with R. Edward Freeman writing that “stakeholder theory can be unpacked into a number of stakeholder theories, each of which has a ‘normative core,’ inextricably linked to the way corporations should be governed,” with a “normative core” being any moral theory.
But requiring directors to manage the corporation in accordance with some particular moral philosophy is utterly impractical as a form of corporate governance. Finding individuals competent to serve on the board of a public company is already difficult. Requiring that these individuals also be knowledgeable about some particular moral philosophy and willing to commit to manage the corporation in accordance with that philosophy is fanciful. Moreover, such an arrangement would be highly unstable. Directors are elected annually. If the market did not share the board’s moral philosophy, activist investors would unseat directors who intentionally reduce shareholder returns to implement moral principles not widely shared by the shareholders. A morally unified board could not long survive at a public company.
The Political Interpretation
Finally, each director could simply vote in accordance with his or her own moral views, whatever these may be, doing whatever he or she thinks right in the circumstances, even if this involves transferring value away from shareholders and to other stakeholders on a net basis. But why is such power legitimate? Especially when the class of stakeholders expands to all of society, why should a small number of individuals be entrusted with managing vast aggregations of resources to advance their own particular notions of what amounts to the public good?
The only obvious justification for such an arrangement would be that, like government officials, the directors obtained their positions through some legitimizing political process. The problem, of course, is that directors are elected by shareholders, not by stakeholders generally, and it is implausible that individuals elected by one group of people will give due consideration to the interests of other groups of people. The clear implication is that all stakeholders should vote in the election of directors.
Now, the corporate franchise may be extended to employees, as in the German co-determination system, and perhaps something similar could work for creditors and suppliers as well. It is difficult to imagine such a system being extended to customers, however. Would you get one vote in the election of directors at Coca-Cola for every coke you drink? One vote in the election of directors at Google for every search you run? How would otherwise unrelated third parties affected by the company’s greenhouse gas emissions be awarded votes?
Worse, if everyone affected by the corporation’s operations got to vote in the election of directors, almost everyone would vote in the election of directors at almost every company. The average American would be entitled to vote in the election of directors at thousands of companies, most of which he or she knew nothing about—indeed, had probably never even heard of. The result would be rational apathy. With turnout very low, the resulting elections would not really legitimize the power of the individuals elected to be directors.
A more feasible alternative would be to have directors appointed by government officials who had been democratically elected. Perhaps the president could appoint the directors of all public companies in the United States. Shareholders would retain an economic interest in the company (for what that might be worth in such a system), but they would have no control, which would pass to the government. In its political version, stakeholder theory seems to be a mere inefficient half-measure on the road to socialism.
Robert T. Miller is Allison and Dorothy Rouse Chair in Law at the Antonin Scalia Law School. This post is based on his article, “Interpretations of Stakeholder Theory: Economic, Philosophical and Political,” which is a contribution to a special issue of the Journal of Morality and Markets on business law and philosophy and is available here.