The Unreality of “Stakeholder Capitalism”

To mark “the second anniversary of the Business Roundtable’s Statement on the Purpose of a Corporation”, the director and associate director of the Harvard Law School Program on Corporate Governance examined whether corporations whose CEO’s signed the Statement have acted as if they regard themselves as “guardians of the interests of ‘stakeholders,’ such as customers, employees, suppliers and communities as well as shareholders”. The conclusion: They haven’t. The most decisive evidence:

We found that signatory companies universally continue to pay directors in company stock as a substantial portion of their total compensation. Further, most of the companies still have guidelines that explicitly align the interests of directors and stockholders. In contrast, no company’s compensation practices or guidelines link director compensation with stakeholder interests. The strong alignment of director pay with stock price sends a clear signal that shareholder value is the objective directors are expected to pursue.

Commenting on those findings, Veronique de Rugy characterized the Business Roundtable Statement as “costless virtue-signaling”. “In other words, corporations talk a big game, make big statements, and take actions with zero consequences for their bottom lines.”

That conclusion is about as surprising as “Children who say they want to eat healthy food prefer ice cream to brussels sprouts”. The fundamental problem with “stakeholder capitalism” is that, if seriously pursued, it cuts the stakeholders out of the decision making loop and thus reduces the likelihood that their interests will be well served.

”Shareholder value” is what Thomas Sowell, in his great work Knowledge and Decisions. refers to as a “residual claim”. The shareholders (along with another large residual claimant, the government) get what is left after the corporation has collected the revenues for its goods or services and satisfied the costs incurred in producing and delivering them. In other words, nothing that the shareholders can do generates value for them. That value is derived from other parties’ decisions. The shareholders who most acutely monitor the way in which corporate management utilizes the knowledge conveyed by those decisions are the ones who wind up with the largest residual claims.

The non-shareholder stakeholders listed by the Business Roundtable – customers, employees, suppliers and communities – know their own interests and desires. Moreover, they can communicate those in the form of – another Sowell term – “effective feedback”. Customers buy or don’t buy what the corporation offers for sale. Workers accept, remain in or leave employment with it. Suppliers decide whether, and at what prices, they will deal with it. Communities provide a welcoming or hostile business climate through taxes, zoning laws, the quality of municipal services and other measures. Shareholder value is ultimately the result of the stakeholders’ net evaluation of the benefits and costs of dealing with the corporation.

The Business Roundtable Statement’s signatories purport to substitute something else for the process just described. What the new process might be, they don’t say, but, whatever they had in mind, it will be better for the stakeholders only if it conveys their interests to the corporate decision makers more effectively than concentration on shareholder value, which can be maximized only by attending to the preferences of customers, employees, suppliers and communities, as expressed through their feedback. The implicit premise is that those expressed preferences are less than optimal for the stakeholders and would be improved if some other party substituted its judgment.

From the point of view of a third party, it’s obvious that workers would be better off if they were paid more for fewer hours, customers would be better off with lower prices, suppliers would be better off with higher prices, and communities would be better off if resident corporations paid higher taxes and acquiesced in fewer services. Everybody would be happy, except that, without effective feedback from those various parties, there is no way to balance their conflicting desiderata in a way that satisfies everyone to the greatest extent that is actually possible. In practice, “stakeholder capitalism”, if genuinely implemented, would have the same untoward consequences as wage and price controls: surpluses here and shortages there and everyone worse off than before

Among the worse off would be, naturally, the corporation's shareholders, whose residual claims would be diminished. They wouldn’t be likely to tolerate that situation for very long, at least not if a free economy allowed them to take their capital elsewhere. Practicing “stakeholder capitalism”, as opposed to preaching it, is corporate euthanasia. When they aren’t trying to impress others of their class with their superior sensitivity to the plights of others, CEO’s and their boards of directors understand that, and so they reconcile themselves to the sinful money grubbing that leaves all their stakeholders and, as a side effect, their shareholders too, better off.

Comments

[Tom Veal]

Perhaps I ought to have said a bit more. As shareholders conclude that their residual claims are likely to decrease, the market value of the shares will decline, signaling that the company is a less desirable business partner and making it a prospective target for investors whose modus operandi is to take over companies and revamp their business strategy. Either the corporation will die, because lenders will demand higher interest rates, suppliers will offer less favorable terms and customers will lose confidence, or a Carl Icahn will oust the incumbent management.

[bobby b]

"Among the worse off would be, naturally, the corporation's shareholders, whose residual claims would be diminished. They wouldn’t be likely to tolerate that situation for very long, at least not if a free economy allowed them to take their capital elsewhere."

How does this work? I can sell my shares - if I can find a buyer. If a corp begins serving non-shareholders, my share price is going to suffer greatly. Ultimately, once a share is out in the market, how is capital ever removed from the corp?