The ascendancy of stakeholder capitalism: What is its meaning for corporate governance?

Introduction

On August 19, 2019, the Business Roundtable (2019), an association of chief executive officers (CEOs) of America’s leading companies, announced a new Statement on the Purpose of a Corporation (and signed by 181 Business Roundtable CEOs) outlining a “modern standard for corporate responsibility,” one that embraces a philosophy of “stakeholder capitalism” that explicitly recognizes the benefits of all stakeholders, including customers, employees, suppliers, communities, and shareholders, to firm success. On December 2, 2019, the World Economic Forum (2019) released its update—the Universal Purpose of a Company in the Fourth Industrial Revolution—to the Forum’s 1973 Davos Manifesto, a company roadmap placing stakeholder principles into practice, introducing a new statement on what it means for a 21st century business to serve the world.

…[the] new ‘Davos Manifesto’…states that companies should pay their fair share of taxes, show zero tolerance for corruption, uphold human rights throughout their global supply chains, and advocate for a competitive level playing field—particularly in the ‘platform economy’. (Schwab, 2019)

The study will first review (and contrast) the shareholder and stakeholder corporate governance literature. In the case of the shareholder approach, the authors will consider the contractual approach (Easterbrook and Fischel, 1991), the transaction cost approach (Williamson, 1975, 1985), and the agency approach (Friedman, 1970; Jensen and Meckling, 1976). The stakeholder approach will be addressed primarily through the lens of the seminal research work of Freeman (1984). The study subsequently addresses the existing legal corporate governance structure of US corporations (Kim et al., 2010).

The study turns next to reviewing state-level constituency corporation statues (McDonnell, 2004), a predecessor to the recent development of state-level benefit corporation statutes, the latter which explicitly recognizes the array of stakeholders of the corporation (Alexander, 2018). Further, to assess the potential effects of stakeholder capitalism on US corporate governance, a four-dimensional (legal, ethical, economic, and political) evaluative framework is applied to the stakeholder governance approach. In conclusion, a set of practice-oriented recommendations are provided to managers and directors to mitigate future risk.

The methodology employed in the study is offered to facilitate an exploratory framework for stakeholder capitalism. Based on a foundation of legal, economic, and management theories, analytic insights are developed along a four-dimensional (legal, ethical, economic, and political) framework. Each dimension involves an in-depth analysis of the existing academic literature and business media coverage, with conclusions based on the resulting evidence gathered. Methodology limitations include excluding foundational theories; other dimensions useful for the evaluative framework; and because the study is US focused, limited generalizability.

This study contributes to corporate governance theory in the following ways. First, since their inception, the evidence shows that constituency and benefit statutes have not been widely embraced by US publicly traded corporations. Second, while advocating a moral responsibility, limitations of the Business Roundtable and World Economic Forum proclamations reveal that they do not recognize equality in the distribution of material goods, nor require that corporations eliminate economic inequalities in society. Third, there is evidence that stakeholders help provide the firm access to resources and must also be considered as resources whose value and importance to the firm is contingent on the organization of its network and constituents. Fourth, stakeholder capitalism expands the power of publicly traded corporations beyond the limitations of the business judgment rule to encompass policy issues related to stakeholders and society.

From a practice perspective, the study offers the following managerial recommendations. First, directors should reconsider incorporating under a benefit statute, thus explicitly recognizing the value of all stakeholders. Second, the essence of both the Business Roundtable and the World Economic Forum proclamations could be embedded in the corporate mission statement and implemented through its corporate code of conduct. Third, combine longer term firm sustainability with an intensive business lobbying effort focused on reducing benefit statute compliance requirements. Fourth, institute efforts to build ad hoc political coalitions on issues where the firm shares common interests with nontraditional stakeholders, for example, nonprofits.

Contrasting shareholder and stakeholder governance perspectives

The shareholder perspective of corporate governance is primarily based in an economic approach to organizational formation—namely that a firm is conceived as a nexus of contracts between a legal entity (the corporation) and its constituencies, including employees, customers, suppliers, and investors (Hart, 1989; Macey, 1991). Shareholder governance has origins tied to the 18th century joint stock company, where a small group of investors combined their financial resources for a commercial undertaking they could not finance individually (Easterbrook and Fischel, 1991). This form of business organization represented an extension of property rights and the right of contract enjoyed by all individuals (Easterbrook and Fischel, 1991), a contractarian approach built upon a transaction cost economics (TCE) view of the firm.

Under the TCE view, an increased financial return to constituents is predicated on reducing the transaction costs of productive commercial activity by locating this activity into a hierarchical organization, thus reducing the overall costs of production (Williamson, 1975, 1985). Moreover, agency theory, where the agent (“manager”) is modeled to act for the principal (“shareholder”), supplements the contractarian position that the purpose of the firm is the maximization of shareholder wealth, and the board’s role is to monitor and reward management to ensure that this prime directive is followed (Eisenhardt, 1989; Jensen and Meckling, 1976).

Friedman (1970) has espoused the most famous arguments for the shareholder perspective of corporate governance. As employees (“agents”) of the firm, management holds a fiduciary duty to principals (“shareholders”), their job being maximizing shareholder profit while operating within the “rules of the game.” ² Friedman (1970) further argues that the social responsibility of a corporation is to ethically and legally maximize profits and not spend company profits on social responsibilities for noncontractual stakeholders—the latter a form of managerial decision-making which violates contractual agreements and expends other people’s money without their consent (Hasnas, 1998).

The modern idea of the “stakeholder” was developed separately by the Stanford Research Institute and Swedish management theorist Eric Rhenman in the 1960s (Freeman et al., 2010). By the 1960s, corporate strategy scholars, such as Kenneth Andrews and Igor Ansoff, used this term explicitly in their writings and strongly suggested that stakeholders might have something to do with a company’s strategy formulation process (Freeman, 1984). Yet, the seminal work in stakeholder theory was developed by R. Edward Freeman in his 1984 book Strategic Management: A Stakeholder Approach.

According to Freeman (1984: 46): “A stakeholder is any group or individual who can affect or is affected by the achievement of an organization’s objectives.” Stakeholder theory is a set of propositions suggesting that firm managers have governance obligations to many stakeholder groups beyond shareholders (Freeman, 1984) (see Figure 1). Yet, Freeman et al. (2010) argue that all stakeholder theory recommends is that corporations should pay attention to affected interests, and shareholder theory is simply a variation of stakeholder theory. Recent research recognizes that most firms are embedded in a complex network of stakeholders, with many of them in independent relationships with each other (Rowley, 1997). Furthermore, Jones and Wicks (1999) have offered a strongly moral-based view, which they refer to as “convergent stakeholder theory.”

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Figure 1.

Stakeholders of the corporation.

We next turn our attention to how the shareholder perspective has actually been instituted in publicly traded corporations, using the US legal domain as an example of wealth-maximizing in the corporate governance process. ³

Traditional US corporate governance

US corporations consist of those publicly traded (on market exchanges) and those privately held (by an individual or multiples of individuals). The corporate governance process described here is associated with publicly traded corporations and their boards of directors. Each of America’s 50 state governments has its own incorporation laws—although they all generally follow the “Model Business Corporation Act” (Kim et al., 2010).

Under the traditional shareholder primacy model of corporate governance, the shareholders are the legal owners, and corporate officers act as “agents” for the benefit of the firm’s shareholders (“principals”) (Anand, 2008; Kim et al., 2010). The board of directors, a legal requirement of all state incorporation laws, is elected by the shareholders and is delegated authority by shareholders to provide the strategic direction for the corporation; to offer advice and counsel to the CEO; and to monitor the performance of executives to ascertain whether they are meeting the company’s legal and financial obligations (Anand, 2008). Deloitte (2016: 3) further elaborates, arguing that the “board advises management in the development of strategic priorities and plans that align with the mission of the organization and the best interest of stakeholders, and that have an appropriate short-, mid-, and long-range focus.”

Under state incorporation laws, a board of directors has four main duties (Kim et al., 2010: 43). First, a fiduciary duty to act in furtherance of the shareholders’ financial interests at all times. Second, a duty of loyalty and fair dealing, related to their fiduciary duty, where a director must place the interests of shareholders before their own individual interests. Third, exercising a duty of care by acting in a way that an ordinary prudent person would, for example, by being informed and making rational decisions. And fourth, that a board of directors has a duty of supervision, by establishing a code of ethics, holding regular board meetings to review firm performance, operations, and general management decision-making, and ensuring accurate financial reporting and objective auditing.

Constituency and benefit corporation statutes

The ascendancy of stakeholder capitalism was preceded by two major stakeholder-oriented state legislative movements—the constituency statute and the benefit statute—offering incorporation alternatives to the traditional shareholder model of corporate governance. In 1983, the first “constituency statute” was passed in Pennsylvania (McDonnell, 2004). Under constituency statutes, a corporation’s officers and directors are allowed to give weight to the interests of non-shareholder stakeholder groups in the performance of their fiduciary duties (McDonnell, 2004). All constituency statutes mention employees and customers, while some mention suppliers, local communities, state and national economies (although each constituent lacks legal standing to sue under these statutes) and specify that directors may consider the long-term and short-term interests of the corporation (McDonnell, 2004). Without clear case law, many directors fear civil actions if they stray from their fiduciary duties to maximize profits (McDonnell, 2004). Nevertheless, 34 states have enacted constituency statutes (Dizikes, 2016).

What has been learned about the effects of constituency statutes on shareholder behavior? Geczy et al. (2015) empirically investigated the impact of constituency statutes on investment decisions by high fiduciary duty institutions, including public and private pension funds, as well as endowments, which explicitly forbid sacrificing monetary returns in pursuit of nonmonetary corporate goals. According to one of the authors of this study:

Our data set—which spanned over thirty years and included all 50 states—demonstrated that HFDIs did not significantly decrease their investment participation in response to the passage of constituency statutes. While we cannot rule out that constituency statutes had some effect on HFDI investment, we can rule out that these investors significantly altered investment behavior after the passage of constituency statutes, as one might expect if these institutions perceived material conflicts with their fiduciary duties. (Tucker, 2015, emphasis in original)

Tucker (2015) notes that her and her colleagues’ study may provide some insights into the acceptability of benefit corporations and other alternative business forms, as they are “cautiously optimistic about capitalization prospects of alternative business forms,” although “not an unqualified green light for alternative [corporate] entities.” Over the last few years, Warby Parker and Etsy, both benefit corporations, have gone public, with Etsy offering a US$300 million initial public offering (Tucker, 2015). Yet, while more than 3000 companies are now registered as benefit corporations in the United States, this comprises only 0.01% of American businesses (Stracqualursi, 2017).

One factor contributing to slow growth could be onerous reporting requirements. Most states offering benefit corporation status require filing annual benefit reports, available to the public on the company’s website, which assesses the business’ social and environmental performance in meeting its public benefit purpose (Stracqualursi, 2017). If the company fails to show a commitment to working toward these public benefit goals, it can lose its public benefit status (Stracqualursi, 2017). Furthermore, benefit company shareholders have the legal right to bring a derivative action against the company (although usually not third parties) to enforce the business’ stated public benefit purpose (Stracqualursi, 2017).

Given this business history with alternative forms of corporations addressing stakeholder concerns, what can US corporations anticipate as stakeholder capitalism is allegedly being embraced by more American businesses?

The four dimensions of stakeholder capitalism

To evaluate the potential effects that embracing stakeholder capitalism will have on the corporate governance of US companies, legal, ethical, economic, and political dimensions have been identified for their complex influence on the firm’s strategic management (see Figure 2).

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Figure 2.

The four dimensions of stakeholder capitalism.

Discussion and recommendations

The Business Roundtable’s recent Statement on the Purpose of a Corporation along with the World Economic Forum’s Davos Manifesto are significant statements that unequivocally recognize that corporations are responsible to all of their stakeholders—not simply their shareholders. Previously, the Organisation for Economic Co-Operation Development (2015) had updated their Principles of Corporate Governance to stress the need for corporations to skillfully consider and balance the interests of all stakeholders. Yet, after reviewing the shareholder and stakeholder approaches to corporate governance, it is evident that even shareholder theory, a theory concerned with how to properly balance (or “trade-off”) legitimate interests, is an instance of stakeholder theory (Freeman et al., 2010: 24).

From a legal dimension, Stout (2012b) argues that US corporate law does not impose any enforceable legal duty on corporate directors or executives of public corporations to maximize profits or share price. Furthermore, Stout (2012b) believes that the economic case for shareholder-value maximization is built on false claims regarding the structure of corporations, including that shareholders “own” corporations; they are the only residual claimants on firm profits; and they are recognized as principals who hire and control board directors to act as their agents. In fact, under the “business judgment rule,” directors are protected from being sued by shareholders for a decision that turns out poorly if that board took all reasonable measures to evaluate their decision (Kim et al., 2010: 43). ⁴ While constituency statutes have been in place since 1983, and benefit statutes since 2010, neither of these state corporation, stakeholder-based initiatives has been widely embraced by publicly traded corporations.

From an ethical dimension, both the Business Roundtable and the World Economic Forum proclamations recognize the potential moral value (or worth) that the various firm stakeholders (beyond simply shareholders) have in supporting the long-term sustainability of corporations in the market economy and the greater society. ⁵ Moreover, these proclamations have a general distributive justice approach, focusing on “providing moral guidance (emphasis added) for the political processes and structures that affect the distribution of benefits and burdens in societies.” To a limited extent, these proclamations resemble a social contracts theory approach to establishing the moral rights of corporations, for example, that through their voluntary consent, corporations are granted rights in exchange for promoting society’s interests (Donaldson and Dunfee, 1999).

From an economic dimension, the purpose of a corporation in society is to create value, that is, goods and/or services, for its customers. Yet, since no economic organization has unlimited resources (including complete knowledge) to draw on to meet all of its corporate governance demands, board and management strategic decision trade-offs are necessary to satisfy stakeholder and organizational demands. This is where the concept of “satisficing” enters into the corporate governance calculus. Satisficing is a decision-making strategy, or cognitive heuristic, which entails searching through the available alternatives until an acceptability threshold is met (Simon, 1956). Satisficing is a key component of Simon’s (1979) concept of bounded rationality, the decision-making assumption that allows company directors to reach a consensus on the necessary socioeconomic trade-offs they confront when approving corporate strategies in a real-world, complex business operating environment.

From a political dimension, many progressives criticize the expansion of economic corporate power in America; yet they support the expansion of corporate political power (through the implementation of stakeholder capitalism as a direct substitute for often inadequate public policy) in corporate governance—an apparent paradox. The mission of the corporation revolves around its economic purpose, while operating within a broader social system. It neither has the public authority (or legitimacy) to independently address, that is, find solutions to, public policy problems. The corporation is bounded by economic and legal constraints but may ethically contribute its expertise within proscribed public policy limitations.

Given the preceding discussion, the purpose of the corporation today is embodied in the following commentary:

Stakeholder Capitalism is a Recognized Commitment, but not a Legal Requirement. The Business Roundtable’s statement on the Purpose of a Corporation is “a fundamental commitment to all our stakeholders,” including customers, employees, suppliers, communities, and shareholders. The World Economic Forum’s Universal Purpose of a Company states that “a company serves not only its shareholders, but all its stakeholders—employees, customers, suppliers, local communities and society at large…through a shared commitment to policies and decisions that strengthen the long-term prosperity of a company.” Both proclamations are commitments that offer moral guidance for a board of directors to ethically consider when exercising their corporate governance decision-making authority concerning stakeholder trade-offs when allocating company resources for “corporate strategies that are intended to build sustainable long-term value” (Business Roundtable, 2016).

These perspectives reflect the current state of the stakeholder capitalism perspective of corporate governance in the 21st century but also lead any reflective manager to ask: “How might the purpose of a corporation under a stakeholder capitalism perspective …?” This question is addressed by providing recommendations on how to tackle the risk assessment process in general terms that may then be adapted to each firm and industry’s unique value chain. In other words, managers can benefit from knowing: (1) In what ways might the stakeholder capitalism perspective change? And, (2) How likely is it that these changes will occur? If managers know this, they may more effectively model the risk to their value chain and improve their stakeholder management process. So, revisiting the dimensions of stakeholder capitalism discussed previously, we provide recommendations for managers moving forward.

The Likelihood of Legal Changes Affecting Stakeholder Capitalism: The legal dimension of stakeholder capitalism is similarly affected by political change but tempered by how legislation is passed and recognized within the United States. For instance, the ruling in Dodge v. Ford Motor Co., 170 N.W. 6668 (Mich. 1919) was the non-precedential opinion of the court that the primary purpose of a corporation is to create profits for stockholders. The decision was binding on those litigants, a ruling taught, perhaps erroneously, in law schools for more than 100 years to argue precedent. Precedents, such as the US Supreme Court’s 2010 ruling in Citizen’s United v. Federal Election Commission that “permits corporate money to influence elections and thereby implement corporations’ values (Ramaswamy, 2020: A17),” are often difficult to overturn and require fundamental changes in the legal system. Naturally, the appointment of Federal and US Supreme Court judges and justices are of great concern to corporations and strategies to manage the risk of sudden changes, brought about by political change, are what “Citizen’s United” was about. One legal strategy for managers and directors would be to reconsider the option of incorporating under a benefit statute, which would instantiate an explicit legal framework on the corporation explicitly recognizing the value (and demands) of stakeholders. However, such legal definitions often bring about increased scrutiny and costs that may potentially be higher than any benefits sought, especially in the near term.

Recommendation: As part of any stakeholder capitalism risk and opportunities assessment, managers must consider how much their company’s internal policy for stakeholder management aligns with current or potential laws (and enforcement). In most cases, profound legal changes in the short term are unlikely; however; monitoring the sorts of events that might trigger sweeping regulative change (e.g. lopsided elections and appointments to supreme courts) that could affect key stakeholder groups is recommended—as is potentially establishing a strategic response team. Unless a firm’s current stakeholder management policies are partially aligned with the regulations resulting in adopting a benefit corporation status, or will need to be in the future, managers may be better off avoiding additional costs and scrutiny resulting from such designation.

A future research agenda holds the potential for a rich array of topics of inquiry. For example, given that there are formal commitments by MNEs being made to embrace stakeholder capitalism, how serious are these firms in showing evidence of implementing this commitment in their corporate strategy? What policy formats are these commitments taking? While many of the firms committing to the stakeholder capitalism model are Western-based MNEs, will this stakeholder capitalism commitment be fully embraced in other areas of the world where there are domestic competitors operating from a shareholder perspective, thus placing these MNEs at a short-term economic disadvantage? Lastly, how does this public commitment to stakeholder capitalism affect the number of firms in the United States that decide to register as benefit corporations?

In conclusion, stakeholder capitalism is now recognized as a concept that boards of directors and executives have explicitly acknowledged. Yet it is a commitment that will be carried out, and potentially expanded, based only on transparent ethical decision-making acknowledging the bounded rationality of legal, economic, and political constraints posed by the organization’s resource capabilities and public policy environment.