Stockholders versus Stakeholders

 

Stockholder Theory Stockholder theory in the 20th century has been largely promoted through the work of Milton Friedman, who states that the business of business is about maximizing stockholder wealth, not “promoting desirable ‘social’ ends.” His philosophical argument rests on the following factors: ·                    Agency theory. The job of managers in a corporation is to do the bidding of their principals—the stockholders. “In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in social custom.” ·                    Market mechanics. If abuses occur, the market will correct them. ·                   Knowledge. Managers are not equipped to decide what is good for the commonwealth. Their expertise is in maximizing profits, not in maximizing social welfare. “[Businessmen] are capable of being extremely far-sighted and clear-headed in matters that are internal to their businesses. They are incredibly short-sighted and muddle-headed in matters that are outside their businesses but affect the possible survival of business in general. This short-sightedness is strikingly exemplified in the calls from many businessmen for wage and price guidelines or controls or income policies.” Still there are limits on the playing field. Businesses, Friedman says, must conform to the rules of the game. He believes that if any abuses occur, the market will correct them. Philosophical Bases Friedman’s work builds on a number of his predecessors, beginning with John Locke, who promulgated the idea of property ownership, and Thomas Hobbes who said people look out for their self-interests. But Hobbes also saw the need for some centralizing influence from the government to take care of those responsibilities for which business was not equipped to handle. Fast-forwarding to the 18th century brings us to Adam Smith. In his landmark work, Wealth of Nations, he proposed his ideas concerning division of labor, which he said would result in a greater good for all. He, too, was a believer in the power of pursuing self-interest, and he stated that promoting one’s own interest was the best way to benefit society. As such, he was an egoist. Like Friedman years later, Smith didn’t trust those who purportedly were acting out of a desire to “do good.” And Smith believed abuses by businesses would be corrected by the “invisible hand of the market” (sounds a little like magic, doesn’t it?). Stakeholder Theory: Kantian Capitalism R. Edward Freeman was one of the first to popularize the stakeholder theory, challenging the idea that the sole role of business was to maximize wealth. Instead he said business must work in the best interests of all those affected by the business, including customers, suppliers, employees, and, of course, stockholders. Each in their own way are vital to the success of the business. And as persons, they deserve respect because of their dignity as individuals and should be treated as ends not as means. Evan and Freeman establish the following principles as part of the foundation to stakeholder theory: ·                    “Principle of Corporate Right (PCR): The corporation and its managers may not violate the legitimate rights of others to determine their own future.” ·                    “Principle of Corporate Effects (PCE): The corporation and its managers are responsible for the effects of their actions on others.” Philosophical Bases of Stakeholder Theory For the foundations of stakeholder theory, we have to go back to Immanuel Kant and his prohibition against using people as means rather than ends in themselves. Evan and Freeman note that “The right to property does not yield the right to treat others as means to an end. Property rights are not license to ignore Kant’s principle of respect for persons. Any theory of the modern corporation that is consistent with our considered moral judgments must recognize that property rights are not absolute.” Which Is the Better Theory? Stockholder theory, which views corporations as economic engines, seems diametrically opposed to stakeholder theory, which views corporations as repositories of stakeholder interests. Freeman points out a number of problems with stockholder theory. First of all, throughout the 20th century we have seen more and more proof that the invisible hand doesn’t work. Where is the evidence? If the market were truly self-correcting then why are there so many regulations in place? The obvious conclusion: Regulations are enacted because the market doesn’t do its job in policing abuses. Evan and Freeman note that “In this century…the law has evolved to effectively constrain the pursuit of stockholder interests at the expense of other claimants on the firm.” The second problem that stockholder theory faces has to do with the economic side of things. Companies are not motivated to correct negative externalities—both because the problem is too big for a firm to handle on its own or it’s more profitable to continue raping and plundering the environment. Evan and Freeman offer an example of the ineffectiveness of stockholder theory when it comes to negative externalities: “No one has an incentive to incur the cost of clean-up or the cost of nonpollution, since the marginal gain of one firm’s action is small. Every firm reasons this way, and the result is pollution of water and air. Since the industrial revolution, firms have sought to internalize the benefits and externalize the costs of their actions.” Stockholder theory also gives rise to such problems of moral hazards and monopoly power. Stockholder theory falls down because of the failure of the invisible hand of the market to correct abuses. Also because it shies away from any kind of moral grounding, it seems incomplete. If we want people to behave morally, shouldn’t we ask the same of our corporations? Why should a corporation, which is nothing more than a collection of individuals organized for some purpose, be stripped of its moral foundation? The main strengths of stockholder theory are its straightforwardness and easy applicability. It does a good job of clarifying who does what in a corporation and for what purpose. Stockholder theory also does a better job of recognizing why corporations exist: to create wealth for shareholders. Stakeholder theory seems more inviting and accommodating on its surface but it falls down at times for being too facile and simplistic. For example, Evan and Freeman propose several structural mechanisms for making stakeholder theory practical: The stakeholder board of directors. Evan and Freeman say it would work like this: “These directors will be vested with the duty of care to manage the affairs of the corporation in concert with the interests of its stakeholders. Such a Board would ensure that the right of each group would have a forum….” The stakeholder bill of rights. “Each stakeholder group would have the right to elect representatives and to recall representatives to boards.” The management bill of rights. “management would have the right to act on its fiduciary duty, as interpreted and constrained by the Board and the courts…” Corporate law. The laws of corporations need to be redefined to recognize that “The corporation should be managed for the benefit of its stakeholders: its customers, suppliers, owners, employees, and local communities.” The problem I see with stakeholder theory is that if each stakeholder has an equal say in the running of the business, then we are avoiding the necessary task of quantifying and setting priorities. It also seems to ignore the primacy of stockholders’ rights to greater rewards because of the risks they take in putting up capital. If stakeholder theory has its roots in a democratic approach to corporate governance, then I say to hell with it. Businesses are not democracies. Democracies are too slow to deal with the exigencies and urgencies that are endemic to the business environment. If every time a business has to make a major decision, it must convene an assemblage of its stakeholders, then that business will never be nimble enough to survive the cutthroat business environment. Where does that leave us? I propose a different kind of stockholder theory, one that puts the role of stockholders first, but that requires corporations to do no harm. And with that prohibition, you automatically eliminate most of the abuses that businesses are known for, but you preserve the ability to act swiftly when needed in making decisions. Businesses are begun as mechanisms for generating wealth for the owners. To ignore that is to ignore what business is all about. Still businesses do not operate in a moral vacuum. To build a strong, stable society, businesses must operate within limits and refrain from inflicting harm onto others. For example, if a chemical manufacturer adopted the stockholder theory with the “do no harm” caveat, it would still seek to efficiently generate profits for its owners. But it would refrain from laying waste to the countryside by polluting the air, ground, and water. Instead, what we would have would be a responsible corporation, but one nimble enough to survive in the rough-and-tumble world of capitalism. If the same chemical firm adopted a stakeholder approach, it would constantly find itself being pulled in different directions by ancillary interests. In the end, such an inefficient approach to running a business would bring about its demise.